Papa John's International Inc (PZZA) 2010 Q1 法說會逐字稿

Good day, ladies and gentlemen. Welcome to the Papa John's first quarter earnings conference call. At this time, all participants are in a listen-only mode. Later, we'll conduct a question-and-answer session, and instructions will be given at that time. (Operator Instructions) As a reminder, today's conference is being recorded. I'd now like to turn the conference to your host, Mr. David Flanery.

Thank you Amy. Good morning. With me on the call today are our Founder, Chairman, and Co-CEO, John Schnatter via conference call from the road. And from here in our Corporate offices we have co-CEO, Jude Thompson, Chief Marketing Officer, Andrew Varga, Senior Vice President of PJ's Food Service and Preferred Marketing Solutions, Tony Thompson, Senior Vice President of North American Operations, Tim North, 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 out lined in our earnings release and in our Forms 10-Q and 10-K, in addition, certain financial measures we use on this call, including earnings per share excluding BIBP, are expressed on a non-GAAP basis. Our GAAP to non-GAAP results reconciliation can be found in our earnings press release available on the Investor Relations section of our website. 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 extremely pleased with our financial performance in the first quarter given the unprecedented promotional environment that John and Jude will address in their remarks. We reported earning of $0.54 per share excluding the BIBP cheese purchasing entity. A 25.6% increase over prior year Q1 earnings of $0.43 per share. Revenues increased 1.7% as compared to the same prior year quarter, with both periods reflecting the impact of new accounting guidance that no longer required us to consolidate certain franchise entities to which we had loans outstanding. The 1.7% increase was primarily due to the increase in the domestic royalty rate to 4.75% from 4.25% in Q1 of the prior year, and increasing commissary revenues due to increased sales volumes and an increase in international revenues, due to unit growth, unit volume growth, and favorable foreign currency exchange rates, partially offset by a 1.8% decrease in comparable sales for domestic company owned restaurants. On a business segment basis, company owned restaurants continued their strong financial performance, as operating income increased $1 million over the same prior year quarter, due to lower commodity costs, labor efficiencies, and the fact that the 2009 Q1 results included a $500,000 charge related to unit closures.

Operating income for our domestic commissary business segment decreased $2.2 million as compared to Q1 of the prior year, due primarily to reduced pricing, the absorption of commodity price increased related to certain Florida vegetable products and higher fuel prices. We continued our philosophy of passing volume and other operational efficiencies through to the domestic system, to help support unit economics in this tough promotional environment. As a result of favorable spot market cheese prices thus far this year, the BIBP deficit has been reduced from $20 million at 2009 year-end, to $16.6 million at the end of Q1. We expect that the deficit will be reduced to approximately $11 million by the end of this year, based on current future's market price projections. Domestic franchising operating income increased $2.2 million due to the previously noted increase in royalty rate, partially offset by reduced unit opening fees, as a result of development incentive programs currently in place. Operating losses for our international segment were $300,000 higher than the same prior year period as expected. This operating loss increase was primarily due to costs related to the start-up of the UK Commissary facility opening in Q2, and increased organizational support, partially offset by revenue increases from unit count and unit volume growth. Operating income for the all others business segment increased $500,000 year over year due to improved results from our print and promotions subsidiary and e-commerce operations.

Unallocated corporate expenses decreased to $2.2 million due primary to the planned reduction in franchisee support initiatives in the current year and higher provisions for uncollectible accounts and notes receivable in the prior year. We repurchased $5.3 million of stock in the quarter and had approximately $28.5 million of remaining re-purchase authorization as of quarter end. We continue to believe returning free cash flow to shareholders via share re-purchase is a good investment and helps support increased shareholder value over time. Our free cash flow, a non-GAAP measure we define as cash flow from operations excluding BIBP, less capital expenditures, was $13.4 million for the first quarter, and $40.4 million for the trailing four quarters, representing a free cash flow yield of 5.3% based upon 27.2 million average diluted shares outstanding and yesterday's $28.26 closing market price. Our net debt provision, a position defined as total debt less cash and cash equivalents declined by $17 million during the quarter, to $56.5 million at quarter end. Our $175 million line of credit expires in early 2011, and we expect no difficulties in renewing the line prior to year-end. We are re-affirming our domestic system wide comparable sales guidance range of negative one to positive one and updating our earnings per diluted share guidance from a range of $1.70 to $1.90 excluding the impact of BIBP to a range of $1.72 to $1.87 reflecting both our Q1 actual results and our views that the current promotional environment will continue for some period of time pressuring unit level margins. And now I'd like to turn the call over to our Founder, Chairman and co-CEO John Schnatter. John.

Thanks David, I would start out by congratulating our franchisees and our core operator on a another very solid quarter. Our stores are rocking and rolling. We have a lot of positive momentum and we're excited, the first quarter was probably the most competitive that I can remember in the 26 years I've been doing this, and in term of sheer volume of media spending and aggressive promotional pricing, but our system held out very strong and our sales are very good and our transaction growth continues to be positive. This will be the fourth quarter in a row, we're extremely delighted with that. The pizza category is healthy and as a whole during the first quarter was gaining traffic from other QSR categories this trend has continued into the second quarter, which we're excited about, with the category remaining healthy and our system continued to gain positive traffic growth. We've seen this game before, short term product and price promotions will come and go. Again, we've seen this time and time again but we've learned that by owning the quality position and we own the quality position in the marketplace it takes years of discipline. It takes years of focus and takes years of effort, (inaudible).

Last week, as you heard, we had the pleasure, from our Board of Directors, to promote Jude Thompson to serve as our co-Chief Executive Officer. I congratulate Jude on his promotion and am delighted that the two of us will continue our work together, now as co-CEOs. This appointment, simply recognizes the partnership that Jude and I developed while working together over the last 30 months. I've known Jude for 20 years and he's been on the Board for two and a half years. It allows us to divide our CEO level of responsibilities in a way that our Board of Directors feels plays to our respective strengths. With that, again I want to congratulate the system. I'll turn it over to Jude Thompson for his remarks.

John, thank you I'm also excited about the opportunity to continue to work together along with our very talented franchise, and corporate operators, and management team. First let me start by commenting on our US development efforts, our 2010 US development incentive program has been well received by the franchisees, allowing us to continue to grow our domestic pipeline. Let me share a few highlights. We received four, achieved four net openings during the first quarter versus four net closings at the same time in 2009. Our development pipeline has strengthened considerably over the last 12 months. Today, we have agreements signed to open roughly 250 new domestic restaurants over the next four years and we are on track to achieve our stated goal of 40 to 60 net new domestic openings in the year 2010.

Now to our international business. The international business also continues to show momentum. In the face of a very tough worldwide economic conditions. A few highlights surrounding that business. During the first quarter, we had 18 net new international restaurant openings. We ended the quarter with 706 Papa John's restaurants operating internationally, of which 215 were located in Korea and China, and 155 were located in the United Kingdom and Ireland. Our international development pipeline at the end of the quarter included approximately 1,100 restaurants, most of which are scheduled to open over the next seven years. Next I want to share a couple of changes we recently made to our operations leadership team. First Tim North, Senior Vice President North American Operations has been promoted to lead all aspects of our restaurant operations in the continental US along with Canada, Alaska and Hawaii. Tim has been with Papa John's since 2005 and did an outstanding job as Papa John's Divisional Vice President For the North since 2005. He has hit the ground running, in his new role and we look forward to his leadership.

Next, as announced last week, after briefly leading our international division, President of Global Operations, Bill Mitchell is leaving the Company. We thank Bill for his ten years of service to Papa John's and wish him the very best in his future endeavors. Senior Vice President and Chief Financial Officer, David Flanery, who previously lead the International Division from 2007 to 2009, has resumed the international leadership role on an interim basis while we seek a permanent replacement for this position. Let me add we have three very talented and experienced International Regional Vice Presidents in place, in Miles [Feldt], Jim Thornton, and Jack [Swayzland] along with a strong international support structure we have enhanced over the last few years, this includes Vice President In the Area of International Operations, Support and Training, John [Ishmael], Marketing, Tim Scott, Finance and Development, Joe Smith. This team remains on track to hit our international operating and development goals for 2010.

Finally I want to discuss an important milestone reached by Papa John's system this past week. Papa John's has become the first national pizza chain to achieve $2 billion in online sales. As most of our long-term shareholders know, Papa John's was the first national chain to offer system wide online ordering when we launched www.papajohns.com in 2001. Since that time we have continued to innovate and evolve our online ordering platform, which today includes text, mobile web ordering, and widgets. We will continue to invest in this important area as we expect one day online sales will surpass traditional telephone orders. And with that, I'll turn it back over to David for questions. David.

Thanks Jude, Amy, if you want up to open the line up for questions now.

Certainly. (Operator Instructions) Our first question comes from Brad Ludington from KeyBanc. Your line is open.

Thank you. I just wanted to ask on total, I might have missed it, but you talked about the guidance for total domestic net openings of 40 to 60, which is in line, is international development still on par with previous guidance?

Yes. This is David. Yes, no change with the guidance either domestically or internationally as far as net unit development goes.

Okay. Thank you. And just also on the level of domestic closures we saw this quarter was a little above our expectation, is there something unique that happened this quarter or should we expect that to ramp up in future quarters?

We actually, and this is David again and other folks may jump in, we actually had a couple markets where we know stores are getting ready to reopen, it was more some transition between franchisees, so no, I don't at all think that, that you'll see this ramp up as the year goes on. We would hope it actually improve.

This is John, there's not, there's no aspect or particular attribute of the economy that we're not on dead on pace for. If anything, we're a little bit ahead on our development pipeline that goes for comps, store growth, transactions, et cetera.

Okay. Thank you very much.

Thanks, Brad.

Our next question comes from Steve West of Stifel Nicolaus, your line is open.

Hey guys, real quick questions on cheese cost outlook, Dave, what are you guys looking for on cheese right now for the year. Are you still the same where you were before? Or have you lowered the price there.

Yes it's only come down slightly based on the way we charge the stores, so and we have a little detail of that in our 10-Q, it's maybe come down a penny or two at the store level versus what we would have thought a quarter ago. The good news is, though, that does mean we get into eat into BIBP deficit a little more quickly. We'll probably a $1.5 million or $2 million or so favorable in eating the deficit projections for the year versus where we would have been. But it's relatively flat at store level.

Okay. And then moving on kind of where Brad was going with the unit growth. As you look at that, the pipeline is getting fuller, it is accelerating, Jude talked about that, I assume that's from kind of franchise incentives you guys have been putting in place, kind of suspending some of those up front costs, should we expect, maybe is this 40 to 60, is that a conservative number? Could you, is it possible that you guys would beat that number if the franchisees pick up the pace here.

Hey Steve this is Jude, first off we sure hope so that we can do that. Right now we're on track we are exciting about the number of people that have shown interest in the Papa John's brand. I think it's a model that's a winner. During these tough economic times what we try to do with our development program not only in 2010 and 2009, was to get the interests spurred back into it, and those programs last year got the ball rolling and now we continue to move it on. We have to keep our finger on the pulse daily as we watch what happens to commodities, the health of the system is great. We had a very good year last year, and we'd like to continue that momentum, so we feel good that we can hit that mark. We've still got a lot of areas or territories that we could, that are good opportunities for franchisees out there that are interested in being part of the Papa John's family.

Okay and then quick follow-on to that. As you look at this franchise, the kind of incentives you guys have been doing, you've been pulling back a little bit from last year this year, how much longer do you think you'll be doing these incentive programs?

Well, we have so much runway Steve, that the actual incentive programs, they're not that, it's a good investment. Let me say it like that. If you look at the model that we have with royalties, paying into the national marketing fund, a little incentive to help get people, when lending may be tough still in certain areas or markets, we just needed to help along the way, as those dynamics change, we'll see if we could reduce that, but as it stands right now, we think spending a few dollars to have a life long annuity into the Papa John's brand is a good investment.

All right. Thank you Jude.

Our next question comes from Mark Smith of Sidoti & Company. Your line is open.

Couple quick questions for you. First, just looking at the international and just over the last little bit where we've seen some more turnover and Jude, I know you commented on this, is there anything that you can kind of point to, to maybe assuage any fears that there might be issues in international?

Well, Mark, let's talk about that. I want to tell you that, it is absolutely critical that Papa John's wins in the international market. We have, we speak so often as we've just entered our 26 years of operation, we have a lot of runway still left domestically, but internationally, each and every year as it continues to progress, it is so critical for us in the next few years to make it a winning part of this Papa John's team. And I read off some names, Mark, intentionally to, to let you know that it takes more than just one person to, to make something successful. Leadership is important and we will measure twice before we cut. We're going to make sure we get the right fit to lead the international division. There's good momentum there, and we've got great people that work it every day. David is a known entity. He led that area for two years, and but -- being a CFO, that's a full-time job. So we're taxing him a little bit, but we're going to do, find us a world class leader for the international division, and we expect big things out of that division.

And second I know this is tough to commit on for competitive reasons but can you talk about your outlook on price points and how sustainable kind of this $10 price point is?

Mark, I'm going to turn that over to our Chief Marketing Officer, Andrew Varga, and Andrew can make some comments about that.

Yes sure Mark, how are you doing? We feel very good about our ability to compete in this price environment. There's no question that the major offers that are out there about choice simplicity and value for the consumer, and frankly we believe that this has been great for building traffic, and trial while allowing us to be able to up sell to other offers, so we feel good about the pricing environment and how we can compete in it, and if that changes and the value perception changes we'll consistently evaluate our look at pricing.

On the last conference call you guys had talked a little bit about the trends during Q1 and some of the transaction momentum, can you give us an update on how the rest of the quarter turned out as far as the momentum?

David, go ahead.

I'll start and then others will jump in, what as you'll recall, I think what we did say last quarter, only because there was a lot of environmental things going on, we said that we were a little surprised in January a little under our expectations in January, certainly over our expectations in February, and beyond that, Mark, we probably won't comment on a monthly basis for competitive reasons. What we have said is that the fourth consecutive quarter of positive transaction results, we've seen that trend continue into Q2, and beyond that, we probably just won't say a whole lot, but I'll let others jump in.

Mark, this is Jude again, I would frame it a little differently. When we talked last year, there was a plan. There is a master plan, there is when we think about store development, we need growth there. We have a plan behind that, we need a healthy franchise system. We were able to during some tough economic times provide assistance, so it's not only growing them, it's making sure we don't have store closures, so we're looking at all the magical terms such as [FU], FLM and the things that make sure that it is a profitable endeavor for our franchisees, and then you come in and you look at all the other aspects of our marketing. Now Papa's In the House, it has traction. With what we do, what we were most pleased with was we were able turn and now we're into our fourth quarter of positive transactions. We like it. We're going to play our hand. I want to say that is -- stay as humble and hungry as we possibly can, but we really like the position that we're in right now. We're going to keep working our plan.

Last question, kind of a two part. Just looking for any insight into the health of your franchisees. First can you comment on the financing environment that your franchisees have. Then second, can you comment on -- of your pipeline of domestic restaurants. How many of the new units coming into the pipeline are coming from existing franchisees compared to I guess, new operators.

Mark, let me start on the financing and then others will jump in on Part B of your question. It's getting better, I think that's the best thing we can say. The beauty of our incentive program is, it gives the franchisees a smaller amount to need to finance, so the fact that banks are requiring a little more equity on the front end, our franchisees may not be in much different position than they would have been had they had to pay full costs of a new oven, and the franchise fee and so on. That's one of the main reasons we did that is to try to give them that opportunity to go back into the financing market and get deal terms that they're comfortable with. But clearly, there are regional banks that have come to us and said, hey we're open for business. We have certainly heard that GE is getting back in the business of franchise lending. We think all those are positive signs coupled with our incentive program. A franchisee should not be restricted from opening a store because they can't get the funding.

Mark this is Jude to the second part of your question about 75% of this pipeline is from our existing franchisees. So we'd say a proven operator, someone known. But with that said, it's always healthy to make sure that there's interest coming from people that have not been a part of the Papa John's system. So we're excited about that. It's a good mix. It's a mix that we were hopeful for, and it grows everyday. We watch -- as I said we have metrics all over this place. If it moves here, we measure it. Everyday I walk by that little board out there that shows me what's in that pipeline, and it moves every day. We like it.

This is John, to compliment that a little bit Jude. We've sold over 80% of the stores in the first four months this year than we have in totality for 2009. So a lot of positive momentum in the development pipeline. As Jude said, 75% of our growth is from franchisees already in the system. The key to growth is healthy unit economics. We work at that everyday. We had probably the best year ever, last year in unit economics. The nice thing about Papa John's is, we have a lot of cash. I think as David stated our net debt is $55 million. Our operating income for the quarter was $23 million. So we do not have a cash problem. So we -- a lot of our competitors have leveraged up their business. They're balance sheet is unhealthy, we don't have that problem. If we need to develop a POS or an interface for our internet sales, or if we need to help our franchisees out, we have a lot of cash. That is a very good position to be in.

Perfect. Thank you.

Thanks Mark. Our next question comes from Chris O'Cull of SunTrust. Your line is open.

Thanks, good morning.

Hi Chris.

Hi, Jude I hopped on the call a little late so I may have missed your comments regarding the international search. Would you tell us about the search for a permanent President. Are you looking for someone with franchise international experience, retail experience, and when do you expect to complete the search?

Good question Chris. Hello, first, good morning. Fit is so important. Papa John's, I can say this because, I've been on the Board a few years and been -- just celebrated my one year anniversary as a team member, but Papa John's is a unique culture. I know that may get lost when we're talking about the numbers. but quality is a way of life. Most important, we need someone to understand is the Papa John's way - better ingredients, better pizza, live it everyday, you can't skimp, you can't wink at it, you've got to live it, you've got to breathe it -- So, our biggest concern, and/or what I'll will be looking for is someone that has that in their DNA. There are people, and Chris, I said we have a team of people that -- Miles in China and that area, in the Americas, Jim Thornton, and you've got Jack in the UK -- they know their territories. So for a leader, what I want someone as a leader is to have unbelievable love and passion for the Papa John's way of doing things. We have a Board meeting here in three months and I'm very hopeful that I'll be well along the way to start getting them involved. So, three to six months we hope to have that there. Probably if you ask David, who, I've just given him another job, would say he'd like it in three to four weeks, but we're going to be very selective and make sure we do the right thing.

Okay that's fair. It's good. John my next question relates just to promotions. It seems like during the quarter, the Company tried to push some higher check promotions like the extra large four top, which I actually thought was a better value than the $10 pie. But you seem to quickly go back to the $10 pie promotion. I guess my question is do you think Papa John's promotions are really being dictated by what the larger players are doing right now? If so, how do you change that?

Chris, this is Jude. That wasn't a first quarter promotion. That was a period four promotion.

Yes, Chris, this is John. I'll comment then let Andrew jump in. You hit it on the -- hit it dead center when you said -- the category moves extremely quick, quicker than I can ever remember it moving. We're always going to test the price elasticity because if we can sell a $11 pizza versus a $10 we will. Sometimes you push that envelope and you've got to go back until you grab that traffic account. When the largest player's doing a $10 pizza, you can't ignore that. Andrew, why don't you jump in here.

Yes, I think to comment on what we're trying to do is recognize the environment that we're in. There's some simple, easy to understand price points that are out there right now. What we've been successful in doing, though and the Super Bowl was a good example, is having that XL four top coexist with the $10 offer, and mix very well along side the $10 offer. So we feel confident that we can take the $10 price point and up sell where necessary. But we've got to be mindful of the environment we're in. That's the critical piece of this, the value proposition based on regional preferences or economic differences are going to change over time and we're going to be ones to really stay on top of that and evaluate where we go.

Andrew, was that -- the promotion, you ran both of those promotions off and on during the first quarter --

We actually did during the Super Bowl and NFL promotion which we had for three weeks.

Okay.

It was very successful as they coexisted together.

The primary promotion today in the second quarter has been -- the $10 promotion?

It's actually been that same promotion.

Okay, when you think about product pipeline, how does -- is there a play -- can you talk a little bit about the product pipeline and maybe what some of the ideas are that -- is the focus on, continue to be on pizza? Are you guys looking at other opportunities like calzones?

This is Jude. For competitive reasons we try to keep that as close to the vest as possible. I think we've mentioned, Chris, over the years we have a very robust R&D division. We look at things that make it work. It has to not increase complexity at the store level because that's where we get quality and that's where, if it becomes too hard -- so we continue to look at things, LTOs - Limited Time Offers, those are always options for us. But we really wouldn't want to comment on any -- tip our hand any farther out than where we are right now.

That's fair. As fast as the segment moves, I understand that. Thanks.

Thanks Chris.

Our next question comes from Brad Ludington of KeyBanc. Your line is open.

Thank you. I just had a few follow-ups. Starting off, kind of following on Chris' line, when you look at the deal, the $10 pizza, right now, you have the up sell to $2 more for an XL. Can share what the hit rate's been on that? Or whether you feel it's at least been successful?

We like it, but I can't - I would not want to give those numbers away. It would again - our competitors have their plan, we have our game plan and we'd like to make sure we keep that a part of our inside knowledge.

Okay, fair enough. And then on the website. Do you have a target date for when the next version of the website rolls out?

This is Jude. We do. When it's effective, it works, it's right and it's not disruptive. It will happen this year, but we, it's got to have the same quality components and where I see it, how it's being built today, the online system it just keeps us in the game as a leader, and we like it, you could expect something third quarter-ish, we think. But remember this, as technology, it moves so quickly, there will be continued updates, improvement, modules, however you want to view that, that we have to continue to improve daily because you just can't put this on the shelf and say I'm done for the next five years. We'll continue to make sure we keep pace with what our customer base wants from any online ordering company.

Okay. And then, talking about the additional marketing support, it was primarily in the back half of the year. In 2000, you talked about how beside the increased contributions from franchisees -- or from the system, I think there's going to be incremental Company support as well. Last year I think you stated it was $9.5 million in Company incremental support. We were expecting around $4 million from the 25-basis point royalty increase. Can you quantify where that should go at this point?

Brad, I'll jump in here. It's more of an enticement just kind of saying, we're a part of the solution here too -- going back to our system. It's nowhere near those kind of numbers we probably won't give you the exact dollar amount but it's nothing near those size of numbers, it's more kind of just a little sweetener in to the overall system stepping up and increasing the contribution rate.

Okay. And then just a couple others. The commissary operating margin beat our projections this quarter at 9%, should we consider somewhere in the 9% to be a reasonable assumption for the rest of this year?

I think from a consistency standpoint my -- this is Tony Thompson, my response to that would be we're going to continue to leverage our commissary system for the benefit of unit economics with our restaurants consistent to what we've done in the past. We've got a lot of good momentum as Jude said on transactions which ends up helping the efficiency of our system, so I wouldn't want to get too far ahead of saying exactly where we'll land.

The only thing I'll add to that Brad is, that their business very much follows the seasonality of our restaurant business so their Q3 piece count and activity is going to drop just like our restaurants do, so I don't think you could take a Q1 and project it across the full year. There will be a little seasonality to that. On the other hand, positive transactions are a good thing for everybody and they get to take advantage of that.

Okay.

Brad. This is John. We are definitely on a mission to drive this stock price, and to get the $50 a share, you've got to get the $40. You get there two ways, you buy that stock back and you drive that operating income and we're doing both we're on a mission to do both.

Okay. Good. And then final question, looking at the domestic royalty rate, it came in about 30 basis points on an effective basis, about 30 basis points below the stated rate this quarter. Last year it kind of ranged 40 to 50 basis points, should we expect that you'd say somewhere more in the 30s range this year and take that as a sign that some of these concessions are rolling off at this point?

I think that's a fair assessment. It speak to the health of the system, and the levels we've talked about, reducing overall levels of support. I think that's a fair assessment of the situation, Brad.

Okay. Thanks, again, guys. Appreciate it.

Thank you.

I'm not showing any additional questions, sir.

Amy , thank you very much. Thanks,

Ladies and gentlemen this does conclude today's conference. Thank you for your participation and have a wonderful day. You may all disconnect.