Papa John's International Inc (PZZA) 2010 Q3 法說會逐字稿

Good day, ladies and gentlemen, and thank you for standing by. And welcome to Papa John's third quarter 2010 conference call and webcast.

(Operator Instructions)

As a reminder, this conference may be recorded. And now I'll turn the program over to David Flanery. Sir, please go ahead.

Thank you. Good morning. With me on the call today are our Founder, Chairman and Co-CEO, John Schnatter, President and Co-CEO, Jude Thompson and other members of our executive management team. After a brief financial update, Jude will have comments about our business and John, Jude 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 different 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. 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.

Our relatively flat top line performance for the year continued in third quarter as we reported a 0.6% decline in domestic system-wide comparable sales, giving us a 0.2% decline year-to-date in 2010. We were very pleased with our sixth consecutive quarter of comparable positive transactions although the level of discounting required in this very tough economic and competitive environment has pressured our restaurant operating margins, as you will hear more about throughout the call. We reported earnings of $0.32 per share, excluding the BIBP cheese purchasing entity, a 6.7% increase over prior year Q3 earnings of $0.30 per share. Our year-to-date earnings, excluding BIBP of $1.29 per share, were 18.3% higher than the $1.09 per share reported for the same period in the prior year.

Revenues for Q3 of $273.1 million increased 6.5% as compared to the same prior year quarter, primarily due to an increase in commissary revenues from the pass through of higher underlying commodity costs and, to a lesser degree, increased sales volumes. The 4.2% year-to-date increase in revenues was also primarily due to increased commissary sales, mostly the result of increased volumes as commodities were relatively flat and pricing was lower for the nine-month period. The commissary reduced its margins on a year-to-date basis in order to mitigate the margin pressure on restaurants as a result of the discounting environment.

On a business segment basis, Company owned restaurants operating income decreased $1.9 million for the quarter, and decreased $2.4 million for the year-to-date as compared to the same prior year period due primarily to increased levels of discounting, partially offset by increased traffic and labor efficiencies. Commodity costs were slightly unfavorable for the current year quarter and slightly favorable for the year-to-date period due to the previously noted commissary pricing reductions. Operating income for our domestic commissary business segment decreased $400,000 (sic - see Press Release)for the quarter, and $2.1 million year-to-date as compared to the prior year due primarily to pricing reductions, increased fuel costs and for the nine-month period, the absorption of increased vegetable costs resulting from a very harsh Florida winter. Additionally, the prior year results included certain facility closure and management transition costs of approximately $500,000 for the quarter and $1.3 million for the year-to-date.

As a result of favorable spot market cheese prices earlier this year, the BIBP deficit has been reduced from $20 million at 2009 year-end to $14.6 million at the end of Q3. Although, the deficit did increase slightly during the third quarter, due to consistently rising spot prices that topped out at $1.77 per pound. We expect that the deficit will be reduced by an additional $700,000 by the end of this year, based on current futures market price projections and we are pleased to note a substantial drop in the spot market price of cheese over the last two to three weeks to $1.51 per pound, yesterday.

Domestic franchising operating income increased $1.2 million (sic - see Press Release)for the quarter and $6.1 million for the year-to-date, primarily due to an increase in the royalty rate, partially offset by the impact of development incentive programs currently in place, both in the form of reduced unit opening fees and increased incentive payment costs. Operating losses for our international segment were $100,000 higher for the quarter and $700,000 higher year-to-date over the same prior year periods, as expected. This operating loss increase was primarily due to costs related to the start up of our new quality control center in the United Kingdom, which began producing dough in Q2 and started warehousing and distribution activities in early Q3, and increased organizational support, partially offset by revenue increases from unit growth. Operating income for the all others business segment was relatively flat for the quarter and year-to-date periods. Unallocated corporate expenses decreased $1 million (sic - see Press Release) for the quarter, due primarily to reduced personnel costs and decreased $4.7 million for the year-to-date, due primarily to reduced personnel costs, the planned reduction in franchise support initiatives in the current year and higher provisions for uncollectible accounts in notes receivable in the prior year.

We repurchased $18.8 million of stock in the third quarter and an additional $3.2 million subsequent to quarter end through November 3. And we have a remaining authorization of approximately $37.4 million as of that date. We continue to believe returning free cash flow to shareholders via share repurchase 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 $33 million for the first nine months of the year and $36.8 million for the trailing four quarters, representing a free cash flow yield of 5.4%, based upon 26.1 million average diluted shares outstanding and yesterday's $26.17 closing market price.

Our net debt position, defined as total debt less cash and cash equivalents, was $70.8 million at the end of Q3, a $2.8 million dollar reduction from 2009 year-end. During the quarter, we renewed our $175 million line of credit through September, 2015 on very competitive terms. We are updating our domestic system-wide comparable sales guidance from a range of negative 0.5% to positive 1% to a range of negative 0.5% to positive 0.5%, reflecting our negative 0.2% results for the first nine months of the year. And we're also updating our earnings per diluted share guidance from a range of $1.74 to $1.82 to a range of $1.74 to $1.80, reflecting our Q3 actual results. And now, I'd like to turn the call over to our President and Co-CEO, Jude Thompson. Jude?

Thanks, David. I want to start by congratulating both our franchisees and our corporate operators, on a solid quarter in what continues to be a challenging operating environment. In the face of continued, agressive pricing and promotional activity in our catagory, our system posted positive transaction growth for the sixth consecutive quarter. While we have run slightly negative comp sales for the quarter and year-to-date, we are pleased that our traffic and customer counts continue to grow. Equally as important, both franchise and corporate operators delivered very strong product quality and service levels during the quarter. When you build your brand around quality, which is what we have done for the last 26 years, nothing is more important for the long term health of our brand than delivering on our, Better Ingredients, Better Pizza, brand promise.

Next, I want to comment on our new restaurant openings and development plans, both in the US and international markets. As I have said before, our brand is 26 years young and we have lots of runway to grow throughout the world in the coming years. During the quarter, we achieved 67 worldwide net unit openings, a 68% increase over the same quarter in 2009. This included 34 net new units in the US, compared to 21 during the third quarter of 2009. Looking ahead, our development pipeline is strong with agreements in place to open approximately 270 additional restaurants in the US, of which 80% are scheduled to open over the next two to three years. And on the international front, we have agreements in place to open roughly 1300 restaurants over the next seven years or so. I commend our development team for the job they have done in building our development pipeline and producing solid store openings throughout the world.

Next, I want to mention a few international highlights. During the quarter, international franchise system sales increased nearly 20% to $75.8 million, from $63.3 million in a comparable period in 2009. We also achieved 33 net new international restaurant openings during the quarter, including the first two franchise openings in the country of Columbia. And in August, we appointed veteran restaurant operator Tom Sterrett to lead our international division. Tom has been with Papa John's for more than 15 years serving in a variety of operation roles. Most recently as Papa John's Division Vice President for the South Division since 2008, where he helped lead the division to record sales and profits. Tom is an extremely talented operator with tremendous operations experience and we are pleased to have him lead our growing international business. John and I were able to do a world tour with Tom during the third quarter, visiting international markets from China to the Middle East to the United Kingdom.

While in the UK we celebrated the opening of our newest quality control center. It is a state-of-the-art facility producing outstanding quality fresh dough. And gives us the capacity to serve up to 600 restaurants in the United Kingdom.

Finally, I want to close my remarks by commenting on another important investment we made in our business just after the close of third quarter. That is, in October, we launched our revamped online ordering site at papajohns.com. The new site features enhanced graphics and upgraded features that make it easier and faster for customers to order. And offers the only national online pizza loyalty program. Our early investment in online ordering, which we launched in 2001, has continued to pay off, as earlier this year our system became the first national pizza chain to surpass $2 billion in online sales. Our latest investment in this area also includes a new mobile website that has been optimized for smartphones and we plan to launch an iPhone application by the end of the year. And with that, I'll turn it back over to David for questions. David?

Thank you Jude. You can go ahead and open up the line for questions.

Yes sir.

(Operator Instructions)

Our first question in the queue is Steve West, Stifel Nicolaus. Please go ahead.

Good morning, Steve?

Good morning, Mr. West, your line is open.

Nope.

All right. We'll proceed to our next questioner. The next question in the queue is Michael Wolleben with Sidoti and Company. Your line is open.

Hello. Good morning, guys.

Hello, Michael.

I just wanted to go back and touch on the competitive landscape that you guys are in right now. With both of your larger -- two larger competitors heavily promoting that -- their discounted menu items and where cheese prices look to be heading here, doesn't look like they're going to have to roll back those discounting -- at any time soon. Where do you guys feel you stand here, competing against those guys in this environment and is there an opportunity for you guys to -- are you guys looking at lowering prices any or are you guys going to stick with that $10 and $11 price points where you guys are at today?

Michael, this is Andrew Varga. How are you doing? We're not going to get into specifics about our pricing strategy. But, one of the things I will say is that this is a unique environment. And we are going to be very strategic about where we use and leverage discount and balance it out against opportunities to leverage higher price points as the quality leader. We've been pretty consistent with that, particularly over the last four or five months. We have been 26 years on quality. So, we're going to continue to reflect that in the way that we price and make sure that we're responsible with that.

Okay. Next here, looking at the development incentives that you guys rolled out here in 2010, I know that you guys got the benefit of those openings that are currently not paying a royalty fee as we move into '11. Do you have guys any ideas here on what kind of development incentives you might have to roll out in '11? And would there be a possibility of you guys doing another zero royalty for new openings in '11, do you think?

I'll start. We haven't announced anything publicly yet, Michael. I can tell you we like the results we've seen from the 2010 plan an awful lot. And with that, I'll see if Jude, John or--.

Michael, one of the things about being a 26 year old brand, is that we have so much territory, not only in the US, internationally, I've spoken to that. And we think it's smart business to put an incentive during these tough economic times, getting access to capital is not always the easiest deal in today's environment. And if we can bring in the quality of new operators, that I get to meet each and everyday, into the Papa John's system, we think long term that just makes a lot of sense, business sense.

And, Michael, if you think about it, we do get some immediate benefit from the stores opening, even though the royalty stream may be deferred, they automatically start contributing into the national marketing fund. They are buying their goods from PJ Food Service. So, that gives us immediate benefits as a system. And then once they work through that waiver period, so, as this program proceeds, then they start rolling into the royalty. There's some kind of delayed benefit but there is some benefit that is immediate.

Okay. And then lastly here, can you guys speak a little bit about the deal you guys did with the NFL sponsorship and what kind of benefits you're seeing there and what kind of opportunities you see going forward?

Absolutely, Michael. This is Andrew, again. We're thrilled with the progress and results of the NFL relationship. And the best part of it is it continues to build momentum as the season goes on, which is exactly what you want when you invest in a sponsorship. So, I'm not going to get into the key details of sales, progress and all that. But suffice it to say, we're very pleased where we are.

Great. Thank you.

Thanks, Michael.

Thank you, our next questioner in queue is Mark Smith, Sidoti and Company

Hi, guys. Two questions that are kind of follow-ups that have been asked here. First, just looking at you brand positioning, as a quality leader, by following others, and continuing to discount, does that have some risks to it, for where you guys have set up your brand position, as the quality guys?

Hey, Mark, this is Andrew. We don't believe so and I'll tell you why. This is a very very unique environment, and one that, I would suffice to say, the pizza category has never seen, a lot driven of it by the economy for sure. We've got to be smart about how we price, how we leverage, Better ingredients, Better Pizza, and how we leverage our quality positioning. We really feel good about how we are doing that through pricing, through smart promotion and making sure that, as you know, from everything we communicate, we just continue to hit home the same message that we've been hitting home for 26 years. We just constantly keep an eye on the environment and what is going on and then call our plays accordingly.

And then second, looking at franchise incentives, outside of the incentive plan for opening new restaurants, can you talk about the commissary margins and your ability to pass some savings back on to your franchisees and if you are able to pull back from that yet, and when do you see that happening?

This is Tony Thompson. We're going to continue to monitor that on a go forward basis, looking out for the health of our system is our primary focus and we are leveraging our Food Service business. I think we have been very consistent in how we have been managing that.

And Mark, one of the things, this is David, to add to that, third quarter is just basic seasonality, our lowest sales volume and profitability at the restaurant level, that's our lowest quarter of the year. So we are probably a little more inclined to look at ways we can help support the system during that quarter. Fourth quarter sales volumes just naturally increase. So that may give you a little look into the way we look at it.

And then last question for me. Can you talk about your outlook for break even results in international and, maybe if you can give us more insight into, excluding the commissary business from international, how that break even point would look?

I'll start. Tom Sterrett is actually traveling today, but what we've said is that our international business, as we currently manage it, should break even by the year 2012. We did make those investments in the UK commissary this year that are being leveraged as the UK continues to add stores.

And, I think, we have said publicly that a disproportionate amount of our overall international loss is in that UK business because of its one store franchisee business model. We are quickly growing our way out of that and we're pretty pleased about the progress there. So, I don't think anything has changed with our outlook on the -- where we're headed internationally.

Thank you.

Thank you. Our next questioner in queue is Brad Ludington with KeyBanc Capital. Please go ahead.

Thank you. Following up and hitting on some of the same points. Starting with the royalty relief and the franchisees, can you comment on what percentage of franchise units are getting some level of royalty relief right now and if you assume you don't do another development incentive in 2011, kind of what percentage that would be at the end of 2011?

I think what we'd say, Brad, is at this point, we probably wouldn't want to get in specifics. We have talked about at any point in time a small percentage of our system is financially challenged, if you will. But, we probably don't want to get into those specifics. I will say that in some cases that relief is more at a market co-op level than an individual store level, anyway. We probably wouldn't want to get into specifics on that.

Okay. And then on the NFL sponsorship, can you comment on what that costs you this year and whether that has already hit the P&L, or if it's going to spread out or how that comes in?

We've been on public record not commenting on the NFL deal in terms of the terms and the costs. As I said earlier, we feel really good about what is going on with it. It continues to build momentum. We certainly can't comment on what the overall deal was.

The only thing I will mention and I certainly agree with Andrew, it is an expense of our national marketing fund, Brad. So, as things get funded into the national marketing fund, that ends up being more evenly spread across our financial statements.

Great. Okay, so, there won't be a disproportionate hit in any given quarter?

There should not be.

Okay. Thank you.

Thank you. Our next questioner in queue is Christopher O'Cull with SunTrust Bank. Please go ahead.

Thank you. Good morning, guys.

Good morning.

Jude, Let's assume that this isn't a unique competitive environment, but to use an over used term, the new normal for the pizza segment. What would Papa John's need to do differently under this -- that assumption to grow its comp sales?

This is Jude. I think that's a fair question and when you think about all the things that I stated today in my opening remarks, there is a lot of things that we have to do that makes sense to us. One, is we just got to take care of the health of the system that already exists, but to grow the system, continue to grow it. So, we were comping over, as you know, last year, a fairly flat year. And so, but our transaction growth is growing and some of that's through new customers, particularly online, a great percentage of them are new to Papa John's. And when we introduce them to the brand, the Better Ingredients, Better Pizza, we think that we are just going to build loyalty over time and that will help us with our comp sales growth.

Chris, this is John Schnatter, good morning. You have to put it in context of over a period of time. If you take Dominos, for example, they've been negative or flat since the end of '05. Pizza Hut, granted has a positive 8 but they're going over negative a 13%. We've had positive trends, flat to positive now for five years. To be in this environment and to have the big guys spend the kind of money they are spending to revamp the product, discount at this level and to be able to hold our own, is quite good. And we're going to come out of this year relatively flat, unscathed, and that's on top of five positive years of growth.

That's fair. Andrew, a follow-up with your two larger competitors though seeing their national marketing fund grow substantially this year, is Papa John's at risk, you think, of lower top of mind awareness?

We don't think so because, as we've spoken to you before, we're spending more on advertising, we're seeing our numbers go in the right direction. We certainly are always looking to spend as efficiently and as effectively as we can. I will just say this, one of the great things about this brand, is that it's been consistent for 26 years. So we don't have to keep changing message and doing all these different things that would affect top of mind awareness and advertising awareness and other key numbers that we track and our competitors track. So, marketing is a beautiful thing when it's consistent. We've been doing this 26 years and feel really good about our position.

In terms of just pricing strategy, I know that -- I believe you guys were -- had a similar pricing strategy as one of the other competitors with $8, $10 and $12 pie. Is there -- is it difficult to grow the check with that kind of pricing strategy in terms of just add-on sales.

Chris, this is Andrew again. Let me first say that there may be a test out in our system where that $8, $10, $12 configuration is going on. But, as a system, we are not adopting that strategy. We do believe that, from a pricing perspective, simplicity and choice and adding value responsibly are the current consumer trends and we try to promote that as much as we can nationally. And what we're finding is when we are smart about it, we're able to add items to ticket, build ticket and certainly, it's not to the same degree in 2008, 2009 environment but, we are definitely seeing progress.

Okay. And then just one last one, a modeling question, David, during the quarter, the Company, it looked like contributed almost $2 million to the franchise marketing initiatives, are you targeting that same amount in the fourth?

We probably won't get that specific, Chris, but we certainly do have some level continuing into the fourth, but I probably would rather not get that specific.

Chris, this is Jude. Also, I think David's earlier comment that this is our lowest PSA quarter of the year and it puts store operators at a tougher time. And so, that assistance that you saw there, we keep -- we have to manage 600 stores ourselves. So, we try keep a good finger on the pulse, and keeping the health of this system moving forward is the right answer every time.

Thanks, guys.

Thank you.

(Operator Instructions)

Speakers, I'm showing no additional questions in the queue. I'd like to turn the program back over to you for any closing remarks.

Thank you very much.

Thanks, everyone.

Thank you.

Ladies and gentlemen, this does conclude today's program. Thank you for your participation and have a wonderful day. Attendees, you may now disconnect.