Papa John's International Inc (PZZA) 2010 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Papa John's fourth-quarter 2010 conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. (Operator Instructions). As a reminder, this conference call is being recorded.

I would now like to introduce your host for today's conference, David Flanery, Chief Financial Officer.

Thank you, Jovan. Good morning. With me on the call today are our Founder, Chairman and Co-CEO, John Schnatter; our President and Co-CEO, Jude Thompson, who joins us from London this morning where he was attending our UK Operators Conference and Awards Dinner yesterday and touring that market -- and Jude will have some more comments on that -- 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 differ materially from the projections discussed today. Certain factors that could cause actual results to materially differ are outlined in our earnings release and in our Form 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. This call is being taped and the replay will be available for a limited time on our website and in downloadable podcast format.

Our domestic topline sales performance trended slightly positive during Q4 and represented our seventh consecutive quarter of positive comparable transactions. The Q4 results drove us to flat sales for the year, although the level of discounting continued to pressure our restaurant operating margins as you will hear more about throughout the call.

We reported Q4 earnings of $0.51 per share excluding the BIBP cheese-purchasing entity, a 24.4% increase over prior year Q4 earnings of $0.41 per share. Full-year earnings excluding BIBP of $1.80 per share were 20% higher than the $1.50 per share reported for the prior year.

Revenues for Q4 of $286.8 million increased 5.2% as compared to the same prior year quarter primarily due to a 2.1% comparable sales increase at Company restaurants and an increase in Domestic Commissary revenues from increased sales volumes and the pass-through of higher underlying commodity costs. Full-year revenues of $1.13 billion increased 4.4% over 2009, due mainly to increased sales volumes at domestic commissaries.

On a business segment basis, company-owned restaurants operating income decreased $900,000 for the quarter and $3.3 million for the year 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 to the restaurants were slightly unfavorable for the current year quarter and relatively flat for the full year, due to certain commissary pricing reductions. The commissary reduced its margins on a full-year basis in order to mitigate the margin pressure on restaurants as a result of the discounting environment.

Operating income for our Domestic Commissary business segment, excluding the impact of an agreement reached regarding the year end BIBP deficit, increased $1 million for the quarter and decreased $1.1 million for the full year as compared to the same prior year period. The increase for the quarter was due primarily to higher sales volumes partially offset by higher fuel costs, and a full-year decrease was due to increased fuel costs and the above-noted margin reduction in support of domestic systemwide restaurant unit economics.

Additionally, the 2009 full-year results included certain facility closure and management transition costs totaling approximately $1.2 million. Domestic franchising operating income increased $1.1 million for the quarter and $7.2 million for the full year 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 openings fees and increased incentive payment costs.

Operating losses for our International segment were approximately $300,000 lower for the quarter and $400,000 higher for the full year over the same prior year period. The full-year operating loss increase was primarily due to costs related to the startup of our new quality control center in the United Kingdom and increased organizational support, partially offset by revenue increases from unit growth. The transition in Q4 to favorable year-over-year operating results reflect improved results for our China Company-owned market and the leverage from overall net unit growth, a trend we expect will continue throughout 2011, leading to expected breakeven results in 2012.

As a reminder, we'll be shifting the reporting of operating results for Hawaii, Alaska, and Canada from International to a realigned North America franchising segment beginning in the first quarter of 2011 and will restate prior year results for consistency. We also plan to initiate reporting of international comparable sales results at that time.

Operating income for the All Others business segment decreased $1.1 million for the quarter and $850,000 for the full year, due primarily to increases in support costs attributable to the enhanced online ordering system, partially offset for the full year by cost reduction initiatives in our preferred marketing business unit. Unallocated corporate expenses decreased $1.8 million for the quarter and $6.5 million for the full year, as compared to the same prior year period due primarily to the reduction in franchise support initiatives as planned, and the collection of certain receivables that were previously reserved.

After considering the impact of noncontrolling interest and excluding BIBP, our effective tax rate was 33.9% in 2010 and 32.9% in 2009. Our effective rate may fluctuate due to various reasons, including settlement or resolution of specific federal and state issues.

We repurchased $3.7 million of stock in the fourth quarter and $46.9 million for the full year. Subsequent to year end, we have repurchased an additional $1.8 million and have remaining authorization of approximately $35 million at this time.

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 $51.2 million for 2010 and $44 million for 2009. The 2010 results represent a free cash flow yield of 7%, based upon 25.7 million average diluted shares outstanding and yesterday's $28.47 closing market price.

Our net debt position defined as total debt less cash and cash equivalents was $52.8 million at the end of 2010, a $20.8 million reduction from 2009 year end. With the expiration of our interest rate swaps in January 2011, the effective interest rate on outstanding amounts under our line of credit has declined from approximately 5.2% in 2010 to a range of 100 to 175 basis points over short-term LIBOR rates in 2011, depending on our outstanding debt levels.

We are reaffirming our 2011 earnings per diluted share guidance range of $2.00 to $2.12 as we expect the favorable impact of early year sales results to substantially mitigate the unfavorable impact of currently projected commodity cost increases, most notably cheese, throughout the remainder of the year.

As Jude will discuss in more detail, we reached an agreement with our domestic system regarding the National Marketing Fund contribution rate for 2011 through 2013. In connection with this agreement, we eliminated the year-end BIBP deficit of approximately $14.2 million and substantially all franchisees have executed a cheese purchase agreement.

As a result, future differences in cheese costs and prices paid by franchisees will be reported as changes in a payable to or receivable from franchisees as opposed to income or expense in our financial statements. And accordingly, we intend to eliminate pro forma reporting for the impact of BIBP, beginning in Q1 of 2011.

And now, I would like to turn the call over to our President and Co-CEO, Jude Thompson. Jude?

Thank you, David, and good morning. I would like to start by congratulating both our franchisees and corporate operators on excellent results in both the fourth-quarter and full-year 2010 in a challenging economy and a changing pizza category.

In the face of unprecedented levels of competitive media spending and discounting in the pizza category, our system delivered positive transactions and sales growth in both the fourth-quarter and full-year 2010. This makes seven consecutive quarters of positive transaction growth by our US restaurants and seven consecutive years of either flat or positive domestic comp sales.

We think these unprecedented results during this timeframe are a testament to the strength of our brand and the quality of our operators. We are pleased that our transaction momentum has continued into 2011. We are coming off the first of our three-year NFL sponsorship which built up momentum and equity with the NFL brand throughout the regular season and playoffs. The sponsorship culminated with a very successful Super Bowl Sunday, where we achieved our goal of selling more than 1 million pizzas at our US restaurants on that single day.

Papa John's continues to be a growth story. In 2010, we posted record sales, including $1.9 billion in global franchise sales and $500 million in global corporate store sales, driven primarily by 177 worldwide met unit openings during the year 2010.

Our domestic development pipeline is strong, with agreements in place to open approximately 300 additional restaurants in the US of which 80% are scheduled to open over the next two to three years. We really like the momentum our domestic development incentive program generated in 2010 and, as a result, we have extended the program into 2011.

As announced in December, and referenced by David earlier, we are also pleased to have reached a multiyear National Marketing Fund agreement with our domestic system. The agreement includes an increase in the national advertising and contribution rate to 4% in 2011, and an agreed-upon minimum rate in the years 2012 and '13. (technical difficulty) and execute a consistent national brand voice, which we think is important at this stage in our brand's history.

The agreement also gives our franchisees the ability to earn royalty rebates by driving sales results and through the early completion of certain image investments in the restaurants.

Now turning to our international business, we continued to drive momentum in this area of our business as we recognize international will continue to gain importance for the growth of our brand in the years ahead. We ended the year with 775 international restaurants and have signed development agreements in place to open roughly 1,200 new international restaurants over the next seven years or so.

During the fourth quarter, our franchisees in Morocco, Panama and the Philippines each opened their first Papa John's restaurant, putting us in 32 international countries. We would note that one of our franchisees in Russia -- Worldwide Papa, Incorporated -- recently listed its stock on the German Exchange raising capital to grow their Papa John's business. Worldwide Papa has a goal of growing the number of restaurants from four of 40 locations in Saint Petersburg and Leningrad over the coming years.

We are pleased with our international franchisees can access the public or private capital markets to provide funds to grow our brand and several have done so. We continue to be on track to achieve breakeven results internationally on a full-year basis in year 2012, even after the reclassification of our Hawaii, Alaska, and Canada franchise operations into a North America franchising business unit that started in 2011.

As we announced last quarter, we named Papa John's veteran operator, Tom Sterrett, to lead our International business. Our International team is deep in talent, decades of experience in the Papa John's system. Their charge is to replicate the success and quality experience of our US operations, the Papa John's way, throughout the world.

Finally, this week, we announced the appointment of Mark Shapiro to the Board of Directors. Mark has extensive experience in the sports and entertainment arena, including currently serving as CEO of Dick Clark Productions. Mark previously served as President and CEO of Six Flags and before that was Executive Vice President at ESPN, where he served for 12 years, primarily in programming and production. We welcome Mark to our Board of Directors.

And now with that, I will turn it back over to David for questions. David.

Thank you, Jude. Jovan, you can please open up the lines now for Q&A.

(Operator Instructions). Steve West from Stifel Nicolaus.

Yes. Hi. Matt Leedon in for Steve this morning. Just a couple of quick questions. I was wondering if you guys have seen much impact from some of the winter weather that we saw, both in the fourth quarter and then obviously quarter-to-date and what impact that has on your business. Whether it is kind of a net positive or if you've had to close any stores because of the weather?

Sure. This is Andrew. I will go ahead and take that. You know, it is kind of a -- it's always a tough one to be able to evaluate because when you get a little bit of snow it is really good for your business; and then you get a lot of snow and it shuts down stores, and you have a challenge to be able to deliver and get open.

So as we evaluated all of it throughout the course of late Q4 and into this year, it's really been a negligible effect when you look at it on balance. And obviously, it's -- as I said, it's a very tough one to be able to kind of say, did you win or lose based on how the weather played out.

And, Matt, I think if we had a situation where we felt like we ought to call something out, I think like Hurricane Katrina or something major, we would call it out. So the fact that we really haven't called anything out kind of supports Andrew's point that it kind of offsets in the big scheme of things.

And this is Tony. We are also very proactive, given where our footprint of stores is from a weather standpoint and planning from supply chain all the way to the restaurant. So we are usually well ahead of difficult weather patterns that move in.

This is John. We are very happy with the start in '11. As you know we look at our business, not quarterly or monthly, we look at it yearly and five and 10 years out. We think the success we are having in '10 and '11, even in this tough environment, is a result of all the good things we did in '08, '09, and '10.

Okay. Great. Thank you. And then also I was just wondering what the plans are maybe a little longer term for Company store growth in the International division?

(multiple speakers). I'm sorry. Go ahead, Jude.

Yes. I heard some of that question, but I think the gist of it is what are our plans with that. And one of the things that we had done early in 2010 was to change our structure where everyone that you are speaking to today has responsibility throughout the world. It's global. It is not international and domestic anymore.

So we are going to take best practices from the US and transfer that into our international markets and vice versa. Quite frankly, some of the new store design and package started in our international markets and we really like it. So the store growth story for us internationally is that we have to have quality franchisees that have the funding and we have to have a supply chain that is in place for us to make that work. And we have got, you know, several markets that we would like to expand into that we are not there today, but we also have runway.

Just as I am here in London, we think we have a wonderful opportunity to quite frankly double and triple the size we are in the United Kingdom. So that is what we're working on doing.

And Matt, the vast majority of that growth will be franchised and as I noted I think in my remarks, we were really pleased with how our Beijing corporate market is performing. But again the vast majority of that international growth is going to be franchise.

David Carlson with SunTrust.

Hello. Two -- one quick question and a little bit longer one. First one is, on the advertising and other related costs line, the expense in Q4 I think was around $13.4 million. With the growing National Marketing Fund in 2011, is the $13.4 million in Q4, is that something we should expect to see going forward? Something of that level? Or was there anything in that $13.4 million that was possibly one-time in nature?

David, Andrew, I'm going to let you all have that one.

I'll start. Mostly, David, the increase in the Marketing Fund contribution rate we do believe will be a shift between types of marketing, not necessarily incremental marketing. I think Q4 may have been a little higher than normal, but I don't think you'll see any major shifts going into 2011. Andrew, if you want to --.

Yes, I mean that's a fair comment, David, and I would just say this, that obviously we are looking to gain a larger national presence with the increase in funding. And we will strategically spend those dollars in ways that we believe will reinforce our better ingredients, better pizza positioning, and help us sell more pieces to our consumers.

Yes, to point in case, we have a leading competitor who upped their marketing substantially last year and had a lot of success running more national marketing.

And, David, the specific thing relative to Q4 is, we were also rolling out our new online ordering site and there was probably a little bit of the incremental cost related to that. But again, in the big scheme of things, year over year, it will mainly be a shift.

Okay. And then, my second one was around the early sales results that you mentioned yesterday and just mentioned a minute ago how pleased you are with how it is going in 2011 and the ability to mitigate the level of food cost inflation expected throughout the year with this level of sales.

On previous occasions if I remember correctly, you've provided some guidance regarding the impact of cheese prices on operating margin in terms of dollars. And then going back and doing the math, it looks like it's around 3 to 4 basis point change in operating margin for every penny change in the price of cheese. What I'm wondering is, in this environment, is that still relevant to think that a $0.01 increase in cheese prices equates to a certain dollar amount of operating margin? And if so, was wondering if you could possibly quantify for us the comparable sales level that would be required to make up, say a 40 basis point decrease in margin, operating margin resulting from a $0.10 to $0.12 increase in cheese prices in '11 if that were to be the case?

Yes, it correlates exactly mathematically the way that you described it if you lived in a linear world. Fortunately we do not live in a vacuum. So, with inflationary pressures on all the restaurant chains while cheese is going up and we don't like it, so are our other commodities and we see price increases in the Restaurant segment that should offset these costs or at least to your point, mitigate it along with the great topline sales we are having.

And David, I don't think we will be anymore specific than that relative to how the year has started off since it is the current quarter that we are in.

Mark Smith with Feltl and Company.

To hit a little bit on the early sales results here -- and maybe I'm looking for too much here, but can you talk about the Super Bowl impact and maybe any swing that that has obviously won?

Well, we won't get into the specific details on swings and things of that nature, but Jude stated it pretty well in his comments. We are thrilled about the progress that we made with the NFL partnership. What I like to think about when I look at partnership marketing is, does it build up momentum over time. And it certainly did that through the greater season, the postseason, and the Super Bowl and we feel really good about the whole season and where we ended up.

And on your NFL sponsorship, is there a risk there given an outlook if we did see a lockout this year?

Well obviously, we hope and believe that there won't be a lockout, but we are protected in our agreement. And I can't get into really any more specifics than that, but football and pizza work great together and we just -- we believe that won't occur, but we are protected in the event that it does.

And then during the quarter, it sounds like you guys saw a fair amount of discounting and really trying to boost and look for strong traffic. Can you talk about how easy or difficult it is to pull that lever and really drive comps on discounting?

Well, it's interesting because we like to look at pricing a couple ways. First of all it's very strategic in the sense that we try to balance when we need to be competitive versus when we need to be [premium] and a great example of that was in Q4 wherein P11 and P12, we ran our Zesty Jalapeno Meats pizza at $11 and ran our Double Bacon Six Cheese LTO at $11 and really felt good about the performance of those.

And so, it's always a balance with us. We are trying to look at where -- you know, what the economy is telling us, what the competitive environment is telling us. But obviously in all scenarios we are trying to leverage our quality advantage that we believe we have and that tends to show up in pricing more for us.

Okay and last question. Jude talked a little bit about the outlook for breaking even in International. It sounds like that is still 2012, just to confirm that.

Yes. I mean, the comments -- you know, are the way we see it and we did reclassify and taking Canada and Hawaii and Alaska, which is the way we manage it over into our Domestic side, that increased the hurdle a little bit, but we liked the momentum and Tom Sterrett and team are doing an excellent job and we've just got -- I've seen it here for the last three days. We have got an excellent group of franchisees that are committed to the Papa John's way, and they believe in it, and they will continue to help us build out this brand. But we are excited about it.

Maybe it's an odd question, but why exclude Mexico from North America?

We don't manage it that way. That's the simple answer. We have different leadership.

Leadership there. Okay. All right. Thank you.

Brad Ludington with KeyBanc Capital Market.

Thank you. I want to start off just getting a clarification on one of the earlier questions on the marketing cost. Did I hear you right that we should see a run rate somewhere in the $13 million range per quarter going forward in 2011?

Without getting too specific, I -- the percentage rate of marketing is not going to be substantially different in 2011 than 2010.

Okay. And then one other clarification on for reclassification of Hawaii, Alaska, and all that. Is the change in international units you showed on the release seems to imply a shift of 45 units. I thought there were a few more. Is that the number that is getting shifted over, 45?

I think it's 66 is the actual shift. And we will show a complete restatement on that in Q1. But I believe it is 66 units.

And then in your guidance that you released in December, you talked about getting -- building the Commissary margin profitability up a little bit. Do you think it's possible we had a -- saw an 8.6% Commissary in other operating margin in 2010. Is it possible to get it back closer to that 9% range that we seemed to average out at over the years?

I will start on that. I think what we said is, in 2010, we had some particularly good rebate programs in place and we helped absorb quite a bit of food cost increases that we wouldn't expect to do that at the same level in 2011. So I think you will see some trending up in margin still well within our agreed-upon levels with our franchise community; but we just did a little extra in 2010 that you won't see.

Okay. And then finally just -- you know, I was wondering it seems like to move up to $11 March specialty pizzas is as -- at least seems to be some success. But do you guys -- if you could comment on this, see any -- when you go from a $10 to $11 price on that, see any measurable trade down or shift in ordering habits?

That's something competitively that we probably wouldn't want to get into. I can comment that this is the third time this month actually that we've run the $11 price point. We feel really good about it and what it does for us overall and you know, we feel -- like I said we feel like it is the right move at the right time.

Back to your Commissary question, the number one priority of the Commissary is to protect the BIBP ingredient shields. So we use the distribution centers as a way to protect our quality and that promise to the consumer is backed up in reality. And that's why we don't have to play the price games that these other guys are playing.

The other thing is the Commissary, we use that to help our franchisees and our corporate operators. Remember, we are the largest franchisee. We are almost in 600 stores. So we have to look at the corporate P&L, the FLM and, frankly, if unit economics are unhealthy you don't have a healthy system. So we use the Commissary as a tool to help unit economics for the system more than we do in looking at how much the Commissary makes. If we run the Commissary correctly, we will grow the system. If we grow the system, the Commissary will make its margin over time.

John, thank you. That was very helpful.

Michael Wolleben with Sidoti & Company.

Good morning. I wanted to circle back to that National Marketing spend again one more time here. It moved up to 4% so we're -- but it's really more of a shift in where it is being spent. But you had mentioned that there's agreed-upon spending levels for future years.

Are we to imply here that that -- that 4% should be moving up here as we move into '12 to try and give you guys an even greater voice competing with those bigger ad budgets that those guys have?

I will take it this way. We do have a three-year agreement in place on the National Marketing Fund contribution rate. We won't be disclosing what two- and three- are, but obviously we believe that having additional funding in our National Marketing efforts are important for us to be able to compete. The increase in the National Marketing Fund obviously gives us more exposure on national TV and the important area of digital marketing where we will have record weeks and record investments in those areas.

And the beauty of the Papa John's story is that we have got plenty of runway to growth that over time. So you know, hopefully, that is a help to you as to how we think about it. And we are excited to be moving in that direction.

But to Michael's question, I think he asked in 2012 does it go up from 2011. Was that the question, Michael?

Yes.

Yes and we've said we don't want to talk about that yet just for competitive reasons. The other thing, I mean, one great way to put more dollars in there which is why we're so focused on it is just adding units. As we add units on the net development, which is why we have the incentives in place, those units from day one start contributing into that National Marketing Fund, they start buying food from PJ Food Service. As John referenced, that just makes a healthier system.

Okay. Got it.

And then on the -- I guess, on the sales momentum that you guys are seeing, in the fourth quarter you still saw -- ticket was down, but you have the confidence even in the face of higher cheese costs to reaffirm that guidance. Can you kind of give us an outlook on where you guys think the competitive environment is going here with cheese costs? Do you see the other guys backing off of these deep, deep discounts and that's a benefit to you? Or do you think that you are still going to be competing on very, very discounted pizzas out there for the foreseeable future even with cheese where it's at?

I'll go ahead and take that. I mean, look, I can't comment on what the others are going to be doing or not doing. I mean, we tend to focus on the plays that we want to run that are really focused on reinforcing our quality day in and day out and, obviously, we look at a number of factors as it relates to price. Whether that is higher commodities, whether that is the economy, frankly it is our own consumers and what they tell us they are willing to pay.

And so as I said earlier, strategically we like to look at it using those as factors and then create either a competitive offer or a premium offer that we think is going to work at the right place at the right time with the right consumers.

And obviously the environment, everybody is dealing with the same issues, but back to following up on what Andrew just said, we feel like we are well-positioned to gain market share in this environment with our brand position and our quality position.

You know, I've been doing this for 26 years. We have seen a lot, if not everything. We learned that if we just run our business the way it is supposed to be run, we do quite well with our brand on our positioning and the quality of our product.

With that being said, I think 2010 was unprecedented in that I've never seen two of the bigger competitors change their whole product and spend the kind of marketing dollars they spent and run the kind of discount they run and us still have positive traffic. So 2010 in our eyes was a litmus test for the brand is very solid.

(Operator Instructions). I'm showing no further questions in the queue, sir.

Great. Thank you very much. Thanks, everyone.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may all disconnect. Everyone have a great day.