Papa John's International Inc (PZZA) 2009 Q1 法說會逐字稿

Good morning, my name is Tikia and I will be your conference Operator today. At this time I would like to welcome everyone to the Papa Johns first quarter earnings 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 session.

(Operator Instructions) Thank you.

Mr. Flanery, you may begin your conference, sir.

Thank you, Tikia. Good morning.

With me on the call today are our Founder, Chairman and CEO, John Schnatter; President and Chief Operating Officer, Jude Thompson; President, USA, Bill Mitchell; Senior VP of PJ Food Service and Preferred Marketing Solutions, Tony Thompson; and other members of our executive management team. After a brief financial update, John and Jude 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. Certain factors that can cause actual results to materially differ are outlined in our earnings release and in our Forms 10-Q and 10-K.

The call is being taped, and the replay will be available for a limited time on our website and in downloadable podcast format.

We were very pleased with our first quarter results in an extremely tough consumer environment. Adjusting for the positive impact of Easter timing on Q1, comp sales were essentially flat for the quarter, which continued the stable trend we had seen developing near the end of Q4 last year. We were also very pleased to once again lead our two major national competitors in domestic net unit growth for the quarter. Our four net closings for the quarter compared very favorably to 25 net closings for Pizza Hut and 60 net closings for Domino's. Our solid comp sales results, coupled with our unit development performance, combined to generate continued domestic market share gain.

Our financial results exceeded our expectations for the quarter, as we reported pro forma earnings per share of $0.43 as compared to $0.50 in the prior year. Revenues were down 1.4% year-over-year, due primarily to the refranchising of 62 company-owned restaurants during the fourth quarter of 2008. On a business segment basis, company-owned restaurants saw $1.4 million improvement in recurring operating income. Operating margin improved by 1.5% due to strong labor management by our operators, helped by the divestiture of the 62 company-owned restaurants in Q4, which were generally lower sales volume units with higher percentage labor costs. Additionally, advertising costs were lower due primarily to the timing of certain discretionary programs. It should be noted that food costs were relatively flat, as higher commodity costs were offset by pricing and product mix.

While the spot market price of cheese was nearly 40% lower in Q1 '09 versus the prior year, the cheese price paid by our company-owned restaurants on a business was slightly higher than the prior year. The BIBP deficit was reduced by $9 million during the first quarter, and based on futures market projections we expect to reduce the deficit an additional $11 million during the rest of the year, while the year-over-year price to restaurants is expected to be lower than the prior year for Q2 through Q4.

Operating income in our domestic commissary unit increased by $1 million over the prior year. This was not our intent for the quarter. However, we underestimated the favorable fuel rates for the quarter in establishing our pricing. We reduced non-cheese margins by 1% in period three, and by an additional 1% in period five, to ensure that the benefit of these continued low fuel prices are passed through to our restaurants. Domestic franchising operating income was $800,000 lower during the quarter than in the prior year, due to fewer new unit openings and the fact that the prior year quarter included $500,000 in fees related to the domestic franchise renewal program. Jude will discuss how we've enhanced our new unit opening incentive program to continue taking market share during this recessionary period.

The international business unit improved its operating loss by $900,000, due to continued leveraging of new unit development and increasing unit sales volumes. The 28 net new unit openings was a first quarter record. This business unit remains on track to achieve profitability in 2010, with a strong infrastructure and outstanding development pipeline. I would like to note, while we're discussing our international business, that we are taking every precaution throughout the world related to the H1N1 virus. Mexico has been the hardest-hit country, but our delivery and carry-out business has actually benefited from the decision of certain municipalities to close all dine-in restaurant activity. It appears as if conditions are beginning to return to normal, without any significant impact on our business.

Operating income for the all others segment was $2.1 million lower in the first quarter, $1.4 million of which was due to the planned reduction in the online ordering fee, and $600,000 of which was due to lower sales volumes in our Preferred Marketing Solutions Division, reflecting the deteriorating general business conditions. Unallocated corporate expenses increased $3.8 million due to the 2009 franchise support initiative, an increase in accounts and notes receivable reserves due to specific collectibility issue, and higher G&A expenses primarily related to severance and other management transition costs such as the CEO search fee.

We closed on the sale of 10 company-owned restaurants in Albuquerque subsequent to quarter end, and later this quarter we expect to close on the acquisition of 11 franchise units in south Florida that will fit well with our existing company-owned restaurants in that market. We repurchased 275,000 shares during the quarter, and 359,000 shares were issued upon stock option exercise, the majority of which were related to the recent management changes. We continue to believe stock repurchase is a good use of our free cash flow, although in this environment you will see us be somewhat more conservative with our already modest level of debt. Our free cash flow, a non-GAAP measure we define as net income excluding BIBP, plus depreciation and amortization expense less capital expenditures, was $49 million for the trailing four quarters, representing a free cash flow yield of 6.7%, based on 27.7 million average diluted shares outstanding and yesterday's closing market price of $26.50.

We are reiterating our full-year earnings guidance of $1.36 to $1.44 per share, which we had raised $0.04 in February from initial guidance announced in December. Although the first quarter financial results were very solid, we continue to be concerned about the impact of unemployment and other economic trends on consumer confidence, and the resulting weakness that creates on the overall restaurant category, including the pizza segment. We are also reiterating our unit growth guidance for the year of 100 to 140 net new units, noting that domestic net growth is expected to exceed initial assumptions and international net growth is expected to fall short of initial assumptions.

And finally, we are reiterating our comp sales guidance of minus 2% to flat for the year, noting that period four results softened somewhat from first quarter trends, with some recovery in early period five. Jude will talk about why we are optimistic about our upcoming line of promotions in his remarks.

And now, I would like to turn the call over to our Founder, Chairman and CEO, John Schnatter. John?

Thanks, David.

I want to start off by congratulating the entire system on a very, very solid first quarter. The significant investments we've made in our system, largely through our franchise support program, are working, with both our franchise and corporate operators thus achieving outstanding success in a very challenging environment. We had our operators exchange this past month, and the morale and excitement at Papa Johns is as high as I've ever seen it in my 25 years.

Next, I want to welcome Papa Johns' Board member Jude Thompson as our President and Chief Operating Officer. Jude has been invaluable to me and the entire Papa Johns system over the last four months during my transition back to the CEO. You will hear are from Jude shortly, and I look forward to the continued partnership with him and the entire leadership team as we continue to move this great brand forward.

Now since our last conference call in February, we have also made significant in -- two big promotions in our senior management team. I congratulate Bill Mitchell on his promotion to President of USA, to lead our domestic operations both corporate and franchise. Bill has been with us for nine years, and just does an outstanding yob job. I would also like to congratulate Tony Thompson on his promotion last week to Senior Vice President to lead our PJ Food Division. Both Bill and Tony and their teams are committed to helping our system deliver our better ingredients, better pizza promise, every day.

In addition to delivering good financial results during the first quarter, more importantly to me, I'm pleased to report that our operators are delivering the best product quality and service scores in the history of the Company, and that's where the rubber meets the road. We will remain focused on delivering a superior quality pizza and superior quality experience. As my farmer friend says out west, I reckon I'll dance with the one I brung, and better ingredients, better pizza, is who we intend to continue to dance with at Papa Johns.

With that, I will turn it over to our President and Chief Operating Officer, Jude Thompson. Jude?

Thank you, John, and good morning.

I'm very excited about joining this world-class company. As we celebrate our 25th anniversary, and our brand heritage of quality, I look forward to helping grow this great brand as we embark on our next 25 years. Obviously, one of the things that makes Papa Johns special and different from other chains is the fact that we have an active, hands-on Founder, who really cares about the quality of our product. I observe John as relentless when it comes to working with our supply partners to ensure we source the best ingredients to make our product.

To highlight this special connection John has with our customers, this week we launched a new reality TV-style national television ad campaign called "Papa's in the House." The ads feature John making special deliveries and being welcomed into real customers' homes. No paid actors were paid in any of the footage, and we really think the ads capture the authentic connection John has with our loyal customers. But the ad campaign is just the beginning of John's special home pizza deliveries this year. Throughout the year, John will be taking a road trip throughout the country behind the wheel of a replica 1972 Z-28 Camaro he sold to buy the bar where John used the broom closet to start making pizzas, which was the beginning of Papa Johns in 1984. On the tour, John will thank Papa Johns team members and loyal customers for 25 years, all the while telling the story of how he is living and breathing the American dream. I would encourage you to log on to www.papajohnsinthehouse.com over the coming months to see photos and videos of John's adventures, and to see which cities he will be visiting.

Now to help others live their American dream, in this challenging economy, last week we announced our 25th Anniversary domestic development incentive program. This best-in-class franchise program offers tremendous incentives to both new and existing franchise owners who sign up in 2009 to open new restaurants. Some of the benefits include no franchise fee, a $25,000 value; no royalty for 12 months; and a $10,000 early opening award. We know we have a franchise model that works, and we are excited to launch this new incentive program to potential business owners who would like to join this Papa Johns family.

Finally, this week we retained an executive search firm to help us recruit a Chief Marketing Officer. We will keep you posted as we look to supplement our already very talented marketing team.

Now with that, I would like to turn it back over to David for questions. David?

Thank you. Tikia, you can go ahead and open up the line for questions.

(Operator Instructions)

Your first question comes from Brad Ludington.

Good morning, guys. Thanks, and congratulations on a great quarter.

Thank you.

You bet. I wanted to start off just by asking, what are your CapEx assumptions for the full year of 2009?

Brad, we're still in the $30 million to $35 million range for the full year. We had a fairly low quarter in the first quarter, but we think that will kind of balance out over the course of the year.

Okay. And then looking at share repurchases, do you expect to continue at least some level every quarter, or should we expect that to lighten up in future quarters?

Brad, what I will say there is we kind of look at that opportunistically, and we also in this environment are very comfortable paying the debt down, so I think you will just have to kind of see -- how we assess the environment going forward will depend on how we want to address share repurchases the rest of the year.

Okay. And then your guidance on paying down $20 million in BIBP debt over the year, I would assume that total debt repayments would probably be above that, combined?

Oh, for the whole Company, yes. Clearly, yes. The $20 million would just be relative to the cheese deficit.

Okay. Thank you very much.

Your next question comes from Michael Wolleben.

Good morning, guys. I was wondering if you guys could comment here on your comments of the opening -- your continuance of the guidance on the net openings worldwide, and what is causing that shift here, slightly less domestic closures, and slightly less international openings? Is that a credit situation here? Are you going to see more openings? Or is that the closures are being kept to a minimum?

Why don't I start out and talk about international and then John and Bill Mitchell and Jude can jump in on domestic. Internationally, I think we just underestimated the impact of kind of the global economic slowdown as we were setting our initial guidance. Overall, we think there will be a 25 to 30 unit shift between that original guidance for international versus domestic. And on international, we opened 140 net units in 2008, which was the most ever. Our guidance was 170 to 190. We probably just got a little ahead of ourselves, given the economic conditions around the world, rather than any specific item in any specific country. And so that is the international side.

Now I will turn it over to maybe Bill Mitchell to comment, or John, on the domestic side, the improvement there.

Thanks, David. This is Bill Mitchell. We believe our foresight in assisting our franchisees has really paid off for us. We have many, many markets around the country that we continue to develop, and again, it was just I think good timing on our part to reinvest in our system with our franchisees, yielding very positive results.

I guess on the same note then, are you guys seeing any improvement in credit availability out there for franchisees that might provide some more upside to those numbers on the domestic side?

This is John. There are kind of two sides to the equation. One is if you drive store-level profitability, that helps a lot on net store closings and it also incents on store openings. The other side is the credit aspect of this, and that is still a very difficult environment, even though we're having some of our most profitable, if not our most profitable, period at store level in the history of the Company, but it is still very light.

And John, this is Bill again. I would add to that that we did hold a lender summit here in February with several franchise lenders, and I will borrow this from our Founder, we don't view ourselves as having 3,400 stores, but one store 3,400 times, so we have put ourselves in the shoes of our franchisees and we're looking at lots of different ways to assist as we see the lenders crank down on making loans.

The other good thing, Michael, I believe about 70% of our domestic development pipeline is with existing franchisees. A lot of those guys are able to build their next new store out of existing cash flow. They don't necessarily need the credit. Where we may feel it is in some of our -- I call them arranged marriages, where you've got a stronger group maybe acquiring a weaker group. Those usually require credit, and we could see some impact on those kinds of deals.

Michael, this is John Schnatter again. While it is a very complex business, it is also very simple business. And if you drive the unit economics, all of the other pieces of the puzzle fall right into place, and we have the resources and I have the patience to continue to drive unit economics, and that's what we're going to do.

All right. And just one last question here. David, you could maybe quantify the impact of the franchisee support initiatives on EPS here this quarter? And are you still looking for that to be around $0.30 to $0.35 this year? Thanks.

I think, Michael, if you look, the two best places to find the impact of that, we had about a $1.4 million decline in our online business units because we changed the fee down from 3% to 2%. And our other impact was about $2.1 million; if you look at that other unallocated section of business segments, there is about a $2.1 million in year-over-year increase, so the two impacts there would be about $3.5 million on Q1. So that would tell you we're about on pace, as we play this out the rest of the year, for what we would have originally said.

Great. Thank you.

Thanks, Michael.

Your next question comes from Mark Smith.

Hi, guys. Just a handful of questions here. First, David, you can talk about G&A expense and kind of the one-time effect of severance and search fees, and what we see leading into 2Q that kind of happened in Q1?

We had some various professional and transition fees. If you again kind of look at the disclosures on that, Mark, you can kind of see the year-over-year level of some of those one-time items. I think we were up about $600,000 on the G&A line same quarter of prior year, so that's a good place to start with looking at what wouldn't be recurring into Q2.

Okay. And do we have a -- I guess a month of that kind of coming in, some of that still in April but maybe not continuing in May and June?

Yes, but also, remember Jude talked about a new CMO position that we will be doing a search for, so the G&A pot is going to have some churning. We will cut some things out in some places, but we do have initiatives in other places, too.

I mean Mark, this is Jude, I want to touch on your subject just a little bit. Given the environment that we're in, we're a business like any others. We have what I would call a little longer-term view, and we think about how we're going to be in 2010 and beyond. But we are always looking at structure and alignment, and we will continue to find opportunities as they present themselves. So I wanted you to know that as we add a CMO position, we think that helps bring us more on the top line, but we realize we have focus on the G&A side of it as well.

And that brings up a good point. Do you feel like once you get the CMO in place, you have really got the team established, or will you look at adding a new international person and let David wear one hat instead of two or three?

Well, those are always opportunities. David has done a fabulous job. International has grown and prospered under his leadership. I think what you're touching on, though, is something all businesses, and particularly we will here, is I love focus and I love alignment, and when you have someone that can dedicate focus, and we're reaching a size now with 600-plus stores internationally, going to 700 in this year, as we continue plans, we will eventually have to address that issue, and we will work with our Board, we will work with David, and we will do what is best for this brand.

Okay. Second, could you guys talk about how you view your return on your investment in this new development incentive program?

I will start out, and John and Bill, you can jump in. It really all depends on -- if you assume we are encouraging someone to open that next store ahead of when they would otherwise open it by as much as say 12 months, or in some cases even more than that, it is a pretty easy return model, because they do buy the food from us, they do contribute into the marketing fund, and then obviously in year two, they will start paying a royalty, so you pretty quickly get the return from having that additional store out there.

Yes, if you take the -- this is John Schnatter. If you take the average unit volume of $700,000, and with royalty and food service alone, you're at probably 5%, maybe 6%, so it is $35,000. If we do have to pay a $10,000 upfront fee to get open early, it is still a 350% return on your money, and the nice thing about that is it is annuity. It is a royalty stream for the next 20 or 30 years. So we look at that as money well spent.

Next, can you give us an update on potential royalty rate increases here either at mid year and also looking out to January of 2010?

This is Jude. Good question. We will continue to look at that as I keep our thumb on the pulse of this Company, and look for the long-term health of our system. There has been no decision made for 2009, and we will keep you posted on that. But we're trying to make sure that when the economy does turn, we're in the best shape to go, and go forward in the fastest and best way possible. I think 2010, we will give you more color on that as the year goes, but we realize we've got opportunities there as a Company, but we want to keep taking a look at the economy that we're in right now, and the health of our system. So more on that a little later in the year.

This is John. All dollars spent, we look at it as shareholders' money, and we expect our shareholders to be rewarded when they invest anywhere with Papa Johns. With that being said, in this environment, we have to make sure that we protect our shareholders so we don't have a $10 stock, and that's what you're seeing in the conservatism of our projections and what we -- things going on. We can't let that happen to our shareholders.

With that being said, in the next two or three years we expect our shareholders to get a healthy return on the moneys that they've spent. You never know what the stock market is going to do, but if we take care of Main Street, Wall Street seems to take care of itself, and we're going to take care of Main Street. We are good at waking up every day and running restaurants. That's what we do, and we do it well. We've been doing it for 25 years, and that's what we're going to do the next the 25 years.

And Mark, what we have said publicly is that as far as our guidance goes, we have not assumed any royalty rate increase throughout the remainder of '09, but we have not yet made that commitment to the franchise system. We've only given them the commitment for the first two quarters of the year, but our guidance does not assume an increase in July. Just wanted to make that clear.

Perfect. And then last question, if I can just get your insight into the competitive environment, and really in two aspects; one, opportunities to take market share, especially as some of your competitors are really diversifying their menu and maybe getting away from their core pizza business, and second, any potential threats on pricing and really having to compete and bring prices down to fight with people?

This is John Schnatter again. We do continue to gain market share. We think that is a good thing. But our competitors are very good at what they do, and we don't take them for granted. The other big guys are good. And of course the independents are good. And you also have the -- the share of the stomach from other fast food places, whether it is tacos or hamburgers. So we respect our competitors, very much so, and we don't take any of our success for granted.

This is Jude Thompson. I will add a few things to this -- to what John said. We're pleased with where we've come from and what activity and market share we have, but we're not totally satisfied, either. We know there is opportunity. We have markets to open, and we have publics to see. I use a term, there is many doors and one destination. You will hear that over the years, and we will continue to try to open up new and different doors, whether that would be non-traditional, or getting into different parts of the population. We know our runway at Papa Johns is longer, and we can continue to gain.

And Mark, very timely this morning, NPD actually put out a release, talking about the competitive and overall environment, the release they put out this morning about total restaurant traffic. For their quarter ended February, total restaurant traffic declined for the second straight quarter, and QSR traffic declined for the first time since winter of 2003. So it is tough out there, and we just saw the NPD release this morning, and that kind of backs that up.

I will ask one follow-up. Jude, you brought up kind of a non-traditional, and looking at your average weekly sales results, it looks like you got a good bump in your non-trad units this quarter, kind of looking at year-over-year and sequentially. Was there anything really behind that?

This is Bill Mitchell. I will answer that question. It it is just continued focus on our fresh dough platform, and we have been able to enter multiple different universities as well as military establishments that have proven to be a good battleground for us as we continue to develop that platform.

And I think you guys have thrown out a number in the past on kind of how big you feel the non-traditional opportunity is. Do you have that?

I think we just recently got to 100, and I think we have thrown out as many as 500, as kind of a mid-term goal. Bill?

No, I think that is a good interim goal for us. This is new and exciting for us. We are seeing that in every one of these nontraditional venues, they love the Papa Johns pizza. And it continues to prove a winner, whether it it is again as I mentioned, our soldiers, or whether it is our students and universities. So again, it is new ground for us, very exciting, and we have lots of opportunities in the future.

Great. Thanks, guys.

Thanks, Mark.

Your next question comes from Chris O'Cull.

Hi, Chris.

Good morning, guys. Let me start with a follow-up on the guidance question. David, maybe help us, what are the comp and commodity assumptions you guys are making, just to meet the center point of your guidance for the year?

Chris, right now, our full-year comp guidance is flat to minus 2. So I think if you -- you know, you take a midpoint there, it would be what we would probably flow through all of our estimate numbers. Commodities, we know that -- we don't know, the futures market says that cheese is going to be ramping up the last two quarters of the year, and the way our formula works, we know that will flow through -- if that happens, that will certainly flow through to our restaurants.

The other commodities are kind of a mixed bag right now, depending on what you hear. The production in some of the meats area, although with the swine flu pork may be down a little now, but there was some concern about meats later in the year. Diesel right now is looking pretty good, but could change based on any kind of worldwide factors there. So I think we're taking kind of a moderate view on the commodity side, except for cheese, where we have a lot better visibility.

Okay. Now, when you think about bonus accrual for the year, are you guys accruing at the targeted level, the center point level, or are you guys accruing for maybe a little bit of upside.

What we do -- that's a good question. I've got a question exactly like that, Chris.

Another way to get to that -- whether we have upside to the guidance.

What we normally do is we look at the quarter's results and our projections for the year, and we will accrue accordingly. That's I guess the best thing I can tell you.

Well, this is John, the bonus is in a way a self-leveling protection for EPS, which we like having that, and we like eating the number, and that way the execs get the bonus and the shareholders get the bump in earnings. So we like the win-win. But it does -- if we don't make the numbers, then there is a self-leveling where the dollars come out of executive pay and they go to shareholders' earnings.

We view it, Chris -- it is kind of like a tax rate, so to John's point, it moderates upside, moderates down side, which is good for shareholders on either way.

I know have you some initiatives planned for the year to kind of help with -- I guess with costs in the restaurants. One of those I think was the rollout of a tip credit wage plan to drivers this summer. Is that still the plan to do that? And what change -- I guess a couple of questions. What changes should we expect from that? And then also, is that reflected in your guidance, any benefit from that initiative?

Chris, this is Bill. Again, great question. And we have disclosed earlier, there are multiple different ways we are looking to mitigate some of the wage increases that we will see this summer. The tip credit wage platform has proven to be a winner for Papa Johns, as well as for our drivers, which again we look at this to protect our internal employees as well as the shareholders. So the answer is we believe that we can mitigate most of the increases that are coming towards us, and we have been able to prove that so far using tip credit as a tool.

Is the benefit -- any benefit from that expected or anticipated in your guidance?

I think, Chris, the answer is it will help mitigate what would have been a larger negative impact from the coming increase in July. So that's kind of the way we look at it.

Chris, this is John Schnatter. There's -- again it is a simple business, in that if you drive transaction and you drive your comps up, and you drive your food and labor and your mileage down, that's how you can make more money. There is probably 20 or 30 initiatives we're doing to drive the FLM part of our business down, but there is also a lot of things that work against us. And on the top line, you are constantly balancing the price elasticity in the market with how do you get more margin, and how do you drive your comps without losing business. So it is a very delicate balance of those four components, but that's our business.

The point of all of that is, is we're not going to find anything that is going to shave 400 basis points off restaurants P&L, but are there 100 or 200 or 300 basis points we could keep chipping away at? Yes. Are we trying to do that? Absolutely. Commodity comes back and cheese goes to $2.00 a pound and wipes some of that out? Yes.

Fair enough. Moving on to promotion, some of your competition obviously has introduced some non-pizza related items; has your opinion changed regarding Papa Johns introducing things such as that, such as subs?

This is John. We watch it, we monitor it. We tested -- we've tested subs, we tested pastas. I will let Bill Mitchell jump in here because he runs the operation, but we're open-minded in that, and we've got probably 18 or 19 things in the pipeline that we could do. With that being said, even when we have our most successful launch of an NTO, then it usually is not more than 8% to 12% of our business. What the consumer tells us is they like our pizza, they like it delivered, they like the way we do that, and that seems to be the backbone of the whole business. But we will have products that come in and out, and you know, subs and pasta may be a part of that.

Okay.

I would just add to that that we owe it to our shareholders and our franchisees to look at all options, and we have done that, we have a very healthy pipeline of products. We like where we stand today in our promotional set, and we like selling pizza. So as John said, we will continue to dance with the one that brought us here, but again, keeping all options available.

Okay. And then one last question regarding international, David, when you talk about the international economics, economic issues altering your expectations for this year, does that reflect weaker comparable sales or unit economics or a difficult financing market for those stores and those markets?

It may be a little of all of that, but I will give you one example. In a couple of countries, we've had some currency fluctuations go against us where product are -- product is imported into that country from the US, and all of a sudden the cost of that product went way up because of currency fluctuations, Mexico being a perfect example of that, Korea being another example. So all of a sudden, margins on a local currency basis just went down in those countries. So once the currency stabilizes we would hope that would recover, but that is impacting the ability for driving those unit openings, and some of that is economics in the country but a lot of it is driven by currency.

Is there any -- is there any way to mitigate that?

We are looking at -- keeping better ingredients, better pizza, at the forefront, we are looking at local suppliers for certain items. But there may be some products that we can't find the right quality local supplier; but where possible, we do try to find local supply chain alternatives that would then mitigate some of the currency fluctuations.

Great. Thanks, guys.

Thanks, Chris.

Your next question comes from Steve West.

Hi, Steve.

Hi, guys. It is Matt in for Steve today, actually. But just a couple of questions on the franchise system, I guess. With all of the initiatives that are in there to sort of revive the system, have there been any more deals similar to the south Florida deal that maybe haven't been necessary now that the initiatives have helped out the franchisees? Are there any specific situations where there really is some significant aid that has been helped, maybe developments, since you guys last updated in February?

I will start, Matt. And then Bill, I'm sure, will jump in. I think the best measure of the success is to have only four net unit closures during the quarter, when certainly our anticipation going into the year would have been at a higher rate than that. I think that kind of demonstrates we've seen good effect from our support program, and so the number of franchisees that may require the level three kind of assistance, if you will, is certainly lower than it otherwise would have been. But Bill or John?

We all warrant to -- want to go from dark to bright but we were concerned about losing 100 stores going into the year, and now we're trying to get back to flat, and the mindset is how do we open 100 stores? So you can definitely tell attitude-wise, we're not near as defensive as we were going into the year, which is a good thing. And now we need to, to your question, go on the offensive, and use this economic situation to our advantage and grow stores and grow share.

With that being said, we have a two-tier approach. The first is the shotgun approach, which is drive FLM down system-wide and make the restaurants healthy, and then the other is the rifle approach, which is the assistance program. We don't call it a hand-out, we call it a hand-up, and it is working. And we're keeping stores alive, and we're turning a lot of stores that were kind of iffy into winners, and that's a big deal in this environment.

All right. Well, I guess, kind of a follow-up to that then, when are the stores going to be healthy enough to sort of reintroduce some of either the royalty rate increases, or if cheese does in fact go up by the end of the year, I mean are these stores going to be able to handle those increases or do they need to be at the current levels to sustain their operations and improve? And I guess how far out should we expect some of these initiatives to sort of be in place?

Malt, this is John again. The franchising is all about relationships, and the amount of goodwill we have created with this program, and again the excitement in the system, this is going to be a very good thing for this brand long-term. And I applaud the shareholders and the Board, who have the backbone to do the right thing and get us through this tough time. This has been a big deal.

It usually takes a year to slow things down, and it takes about a year to speed things up; and again, we're not going to go from dark to bright in a quarter or two. The Board is looking at -- since the dollars are so huge in the assistance program, the Board looks at it every quarter. We meet with the franchise advisor council every quarter, and as things get brighter for the franchisees, we think things should also get better for the shareholders.

Matt, this is Jude. I will make a couple of comments on that. John mentioned we had a great operators conference, opcon, confidence is high. Each and every day, John mentioned also, at the store level they're feeling it in their hip pocket from a financial standpoint, things are -- unit economics, and the things are working in their advantage. And over time that confident continues to grow; they know we're working hard for the long-term health of this system. And so we just really have to keep a hand on the pulse. That is the biggest job we have with this, is to not move too quickly, and not move too slowly. And at this point right now, there is nothing that would suggest we need to back off of what we're doing. It is working, and we need to see it mature a little bit. But we realize that we have opportunities from royalty, and taking that up, and things like that. But it is not the time for that discussion, in our opinion. We will have a little more of that later in the year.

All right. Thanks, guys.

Thanks, Matt.

Your next question comes from Adam [Hemwall].

Hi, guys. When you gave your initial guidance, you said you expected I think 128 to 150 basis point decline in margins. I was just wondering where you stand on that expectation currently?

Well, I think what we said is back in February that would improve a little, because of the cheese market falling so drastically, and that's why we took the guidance up $0.04 in late February, and we're leaving guidance alone at this point. So at this point, we wouldn't have any further revision to that projection.

Okay. And then on comps, you know, you guys were up for the first quarter. Is there anything in particular that might cause negative comps later on in the year?

Adam, this is John Schnatter. The category, what is ir Bill, negative four, five, maybe six, so it is a very tough category, and while the flat comps from the outside may look good or healthy, the thousand things we do every day to run flat is a little bit overwhelming some days, to be frank with you. We work -- we wake up every day trying to get that positive. I think if the category turns positive, I think we are in a very good position to take advantage of that.

I think if the economy continues to get worse, hopefully it won't affect pizza, but if it does, we've got the down side covered, and we come from the school that if you cover the down side the upside will take care of itself, and it is going to have get really, really bad out there for us to not make our number, and that's a position of strength and that's the position we're in.

Thanks, guys.

Your next question comes from Brian Kowalchyk.

Good morning, gentlemen. Thanks for taking my questions. Congratulations on the quarter, especially in this environment.

Thank you, Brian.

Quick question for you, if you could, domestic store margins were some of the best they've been in the history that I've been following the Company over the past several years, especially on the food costs. Could you give us a little more color on the drivers behind the improvement in the food costs, and your outlook as to the sustainability of those margins?

I will start, but Bill and the guys at the store level are certainly the ones making this happen, but clearly we caught a little bit of break with commodities coming down, but if you look in our Q1, our cheese cost was actually a couple of pennies higher than Q1 of last year, so it certainly wasn't cheese. But we did catch a break on some other commodities. But I will let Bill talk about the margins, because they just ran a really good quarter operationally.

Thank you for recognizing that, and I will say the drivers, the Founder, we're lucky to have John back and assisting us. One of our primary goals is driving unit level economics, and this doesn't happen overnight. We know that we can destroy our business in a week, and it takes three years to rebuild it. We have been focused very, very hard on leveraging every aspect, especially food, and I would compliment our franchisees and company operators for running some of the tightest food numbers they've run while providing fantastic products to our consumers.

And then the second piece, which I believe Matt asked the question, was focused on labor, and we've been able to leverage that using our tools, and I think that's what you're seeing in the results with our earnings.

So given all of that improvement, and the anticipation I guess that cheese is going to kind of ramp higher towards the back half of the year based on the current futures market, what's your outlook for sustainability here? Do you think that the other commodities will continue to offer a break, as you said, and that you continue to leverage labor, or do these margins kind of tick down throughout the rest of the year?

I will start, but we do have minimum wage coming in July that we can mitigate, but we can't make it go away, and we know cheese -- again, I say we know, we expect that cheese will be up because of what the futures market is telling us, so we've got a couple of things to overcome. And then I will let Bill and John talk about how we're going to address these.

Yeah, Brian, this is John Schnatter again. We want to be the most efficient operator in the business when it comes from a superior quality of product from the farm or the field to the distribution centers, to the stores, and we have a keen focus right now on our FLM. We are within a half a point of our goal, and so we have raised the bar again, and we want another point, we want more. If we continue to get better at that, and we continue to get more efficient, there is going to be a lot of good news coming out of Papa Johns International.

With that being said, this business, as soon as you think you've got a hold of something, cheese will spike up, or another commodity will spike up, and you can just not take anything for granted. It is a very sensitive business, and the business moves very quickly, and commodities can disrupt things rather quickly. So again, we have the down side covered, and we believe if we take care of that down side, then the upside will take care of itself. I do appreciate you acknowledging the FLM, because that's the primary driver of unit economics, which is my focus. I just think that if stores make money, we all win.

And I will jump in and say, you know, we were at the top end of our guidance relative to comps, at that 0.3, which after you take Easter out is basically flat, so that is the top end of our guidance. If we can maintain that in a tough environment, you quickly lose leverage on negative sales in our restaurant model. So if we could maintain at the high end of our comp sales guidance, then that also will help protect that margin the rest of the year, and make it it more sustainable rather than having the top line erode, and all of a sudden you're losing leverage.

And Brian, this is Jude. I wanted to make one additional point. Some of the questions that came earlier were our views on pastas or sandwiches, and John mentioned that we look at that, of course we do. But when you look at FLM, you also have to look at the simplicity at the store level, you know, what that does with regard to our labor when we offer a lot of different things. We're very consumed and concerned with how we get the best pizza out. And so one of the filters we run new product offerings through is what does it do to the store level simplicity and making sure that we keep our promise of better ingredients, better pizza?

What's a real competitive advantage right now is not only are we running the best, or close to the best, FLM that we've ever run; let me repeat myself, our pizza scores and our service times are the best in the history of the Company. So the better ingredients, better pizza promise is something that is alive and well and more solid than it has ever been, and that's a fundamental belief that I have, that if we get that part of it right, good things will happen in the future.

Appreciate the color. Congratulations and keep up the good work. One other thing in that FLM was the advertising costs, which I guess were held back by some discretionary decisions. I felt that earlier, that there was some expectation that on a year-over-year basis you would actually increase advertising spend to take advantage of some of the weakness in the market, and to increase your profile. What is your outlook for kind of advertising spend, given the current Q1 run rate, or does that look -- do you look to return to a growth profile there?

I will start, and then Bill can jump in. I think if you looked at it overall, we did get more aggressive with advertising, and some of that just shows up in our overall franchise support, kind of system-wide support. And we do have certain specific plans that we don't want to talk about for competitive reasons, where we will fire some of those discretionary programs, they just happened to be timed a little later in the year. But Bill, anything want to add to that?

The only thing I would add, David, is as we looked at this year and continuing our buys, there is a lot of inventory available; that has been very favorable to us in this environment. And to David's point and John's point, when we run this type of FLM, it gives us the freedom to invest where we need if needed in the future.

So are you able to buy essentially more units for the same dollar? Are you buying less units right now? What is happening out there?

Let me speak to it in two fronts. On a national basis, the answer is yes, we have been able to buy smarter, and also been able to purchase more units for the same price, and we are seeing lots of efficiencies for our local operators to buy locally.

Sounds good. David, you can just remind me, the domestic company-owned stores, cheese runs through those operations at spot, correct?

It does on the income statement. If you're looking at the income statement, it runs through the spot. If you are looking at the segment information, which is kind of how we look at the business, it runs through at the same price a franchisee would pay.

Understood. I was looking at the income statement.

Absolutely, then it is the spot.

That's helpful. Some of the metrics that I've been looking at on the international side, revenue and franchise fee, and restaurant sales and commissary sales per average store, are -- have trended down or are down an order of magnitude about 20% on a year-over-year basis. I'm wondering if you can help me about interpret that data, and maybe help me understand what is behind that trend and whether or not you expect that to reverse, get better, maybe a little bit more color on the international side?

Well, there's a couple of answers to that. One is currency. And certainly I think we said our sales were up 11% year-over-year, from the quarter, but they would have been up 30% had we had constant currency rather than the fluctuations, so part of that is currency.

I will tell you a smaller part of that would be an example where we are doing some of our own kind of non-traditional development internationally. One group, for example, in northern Mexico is actually adding a Papa Johns within another branded restaurant concept, so kind of a co-branding, which is going to have lower sales volumes, but still have very, very good returns for that franchisee. So we will experiment some with the model, but the biggest answer is currency.

Got you. And sorry to bring up such a -- kind of an arcane subject on the call, but I want to take advantage of the forum. Can you help me understand the BIBP impact in the quarter, and I guess you said the pre-tax impact was $9 million, and previously I think you had estimated around $11.5 million, but the -- kind of the data end points, with regard to spot price and BIBP price, were almost dead-on. So I'm a little bit confused by the change in the actual dollar impact?

Brian, why don't we take that question offline, and you can just call me back, and I will get into the specifics of that question, because I'm not sure everyone would want to go through the details of that. But if you will call me directly after this call, we can go through the specifics of that.

Sure. I apologize for the nature -- but again, thanks for taking the questions.

Sure thing, Brian.

Your next question is from Brad Ludington.

I just want to follow up with a couple of questions, starting off with -- do you guys provide any regional detail on same store sales performance? Are there parts of the country that are outperforming versus ones that are doing a little worse?

We really don't, Brad. The only thing we've said in the past, last year, is if you looked at where the overall real estate markets were bad, which I think at the time we had said, you know, Florida, Arizona, we were seeing the same kind of softness. But again, that is kind of old news now. And other than that we don't like to give any more color, just for competitive reasons.

We do look at -- this is John Schnatter. We do look at the -- like southwest Florida, where you could actually argue it is borderline depression, we are running good sales in southwest Florida. So we look at it, if the rest of the country goes a little bit farther into the recession, what does that do to our business, do we have it covered? I can't be that positive or that confident, but are we looking at it and do we have a game plan if things do get worse? Yes.

The only other thing we've said kind of on a positive note is we spent a couple of years talking about how tough it was in the northeast, and I think what we have said is that recently that's been probably our best-performing region of the country, so on a positive note.

Okay. And then in the guidance, do you have a specific tax rate built in -- assumption built in for the rest of the year?

About where we ran first quarter. No surprises expected on the tax rate.

Okay. And then we've had a lot of questions that related to foreign exchange. If the foreign exchange, the currency impact remains kind of constant with where it has been averaging in the first quarter, is there any way to quantify what that could do to EPS on a full-year basis?

It will depend on which countries do what, but I will tell you, globally, on the sales side, it is hurting us, as I mentioned earlier, that difference between an 11% growth and a 30% growth. On the profit side, though, because certain units are losing money, when the rate moves down you actually lose less dollars because of a rate change. And so from the profitability side, it kind of washes, so it is just not that significant for us, and we don't expect it to be that significant the rest of the year, either.

Okay. And last question, kind of for John, I don't know if you want to comment on this or not, but you said on the release when you came on, that you're going to focus more on R&D and QA. Is there something new that you're focusing on, or is this more related to try to find the quality sources internationally that you talked about earlier on the call?

This is John Schnatter. Very good question. I meant I'm down in the R&D lab, well, every day, probably three or four times a day, that's where I like to be when I'm not out in the stores. One problem with being the CEO, if you don't have a good support team with you, you get trapped in the building. I view a desk as a dangerous place by which to view the world, so I like to get out and see what is going on in our restaurants, and it is energizing to be out in the field.

I have been to China now three times in the last four years. I just got back from the Middle East. Next week, I go to the United kingdom, England. I will put a little color on International. Four years ago, when Nigel was aboard, I don't think it was as solid as it is now. I think that he and David and Ian and Miles and Jim have just done a fantastic job internationally. Our stores, for example, in Kuwait, [Paul], he is just doing a fantastic job. We're the number one brand -- pizza brand in Bahrain. So there are a lot of solid aspects internationally. We don't have it totally figured out. Why we have some spots of opportunity. But we now have a game plan by which to go about getting us to 1,000 stores, and it is much more solid and achievable than it was four years ago.

With that being said, we have put in rigorous specifications on product quality and measuring internationally, both from a supplier perspective and a consumer perspective, that we didn't have even six months ago, and that's been a keen focus of mine. There's nothing more important than the quality of the pizza, and of course the food safety, to our customers, and that's job number one, and I can tell you we've gotten much better at that.

As far as the US, we're always finding little ways to get better. It is not one or two things that makes the better ingredients, better pizza come alive; it is a thousand little things we do. And we're getting better, I will just tell you that. We have 20 franchisees in today. They -- we're having an ideation session down in the lab from 11:00 to 1:00, and they're going to come in and show us how to make pizza, and show us things and teach us things. And I don't know what is going to come out of today, but I know we are going to get some nuggets from the folks that do this every day. And it is that constant pursuit of excellence that I think is going to be a real cornerstone to our success in 2010 and beyond.

All right. Thank you very much.

Thanks, Brad.

Your next question is from Chris O'Cull.

Thanks. Just a follow-up. The cost of sales improvement we saw at the restaurant level, David, could you disaggregate that a little bit into some buckets for us, in terms of how much of the benefit came from commodity improvements, maybe how much came from an improvement in your actual to theoretical cost gap, promotional mix, that kind of thing?

The biggest single improvement was on the labor side. And honestly, that was just outstanding labor management and execution at the store level, with one added benefit, and that is the 62 stores that we divested in the fourth quarter of last year were generally lower volume stores, which had higher labor percentages because of their volume. So we had a little bit of built-in benefit from the refranchising, but other than that, it was just excellent execution.

The second largest single item was the advertising, which again was just how we spend those discretionary dollars and some things we've got coming up later in the year, so that one was mainly timing/ If you take those two things, that was 90% of the total margin change for the stores. Commodities, honestly, were about flat year-over-year.

As a group?

Yes.

With wheat and everything?

Yes.

Great, thanks.

Again, if you would like to ask a question, please press star then the number one on your telephone key pad.

Tikia, I think we're ready to wrap things up if there are no further questions.

There are no further questions.

Thanks everyone.

Thank you.

Thank you.

This concludes today's conference. You may now disconnect.