Papa John's International Inc (PZZA) 2011 Q3 法說會逐字稿

Good day, ladies and gentlemen and welcome to Papa John's Third Quarter 2011 Conference Call and Webcast. (Operator Instructions) I would now like to turn the conference over to Mr. Lance Tucker. Please go ahead.

Thank you. Good morning. With me on the call today are our Founder, Chairman, and CEO, John Schnatter; EVP of Global Operations & President PJ Food Service, Tony Thompson; Chief Marketing Officer, Andrew Varga, and other members of our senior management team. After a brief financial update, John 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 related 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.

In addition, certain financial measures we use on this call, including earnings per share, excluding BIBP, and free cash flow, 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 in a downloadable pod cast format. As more fully described in our press release, beginning in 2011, we will no longer have operating income for the BIBP cheese purchasing entity, so we no longer need to report earnings on a pro forma basis, exclusive of BIBP gains or losses. We will continue to show 2010 results excluding BIBP, for comparative purposes.

Now, let's jump into our excellent third quarter results. We earned $0.44 per share in Q3 2011, a 37.5% increase over $0.32 per share in quarter three 2010, excluding BIBP. This increase was despite one of the toughest commodity environments in our Company's history. Earnings per share were $1.55 for the first nine months of the year, representing an increase of 20.2% over $1.29 from the comparable period in 2010, excluding BIBP. Our third quarter 2011 revenues increased 11.9% versus the third quarter of 2010, primary due to comparable sales increases of 5.3% for North America, and 4.7% for international, as we continue to see our better ingredients, better pizza message resonate with consumers. In addition, the impact of higher commodity costs on PJ food service revenues contributed to the overall revenue increase, as did a 5.5% increase in the number of units operating globally on a year-over-year basis.

Our unit openings momentum remained strong in the third quarter, with 47 net worldwide units open, bringing us to 134 net worldwide units opened thus far in 2011. On a business segment basis, operating income for domestic company owned restaurants decreased approximately $1.2 million as compared to Q3 2010, due primarily to continued high commodity costs partially offset by excellent positive comparable sales of 6.3%. Operating income for our domestic commissary business segment increased $1.8 million as compared to Q3 2010, due primarily to the higher sales levels and numbers of units previously discussed. Operating income for our North America franchising segment increased approximately $1.3 million due to a 4.9% increase in comparable sales, and an increase in units. The stated royalty rate also increased from 4.75% to 5% at the beginning of 2011, however, the effective royalty rate was fairly consistent between the current and prior year quarters due to incentives earned by our franchisees in 2011. Operating results for our international segment improved approximately $1.6 million in comparison to Q3 2010, primarily due to an increase in royalty revenue from the previously noted increases in units, and 4.7% positive comparable sales in addition to continued improvement in the results of our UK quality control center.

We repurchased approximately $23.4 million worth of stock during the quarter, bringing year to date share repurchases to approximately $49.6 million at the end of Q3. The Company had approximately $29.5 million of remaining share repurchase authorization as of October 26. Our free cash flow, a non-GAAP measure we define as cash flow from operations, including BIBP, less capital expenditures, was $63.7 million for the first nine months of 2011, and $81.8 million for the trailing four quarters. Representing a free cash flow yield of 9.9%, based upon $25.1 million average diluted shares outstanding, and yesterday's $33.02 closing market price. Our net debt position, defined as total debt, less cash and cash equivalents, was $26.3 million at quarter end, a $1.6 million reduction during quarter three.

Based on our strong year to date results, we have several guidance updates to share. The first being an increase in our annual 2011 earnings per share guidance to a range of $2.08 to $2.15. Our previous guidance was $2.02 to $2.12. We are also raising our full year 2011 North American comparable sales guidance to a range of 3% to 4%, up from previous guidance of 2% to 3%, and our full year 2011 international comparable sales guidance to a range of 3% to 5% up from previous guidance of 2% to 4%. Finally, we are raising our 2011 worldwide net unit openings guidance to a range of 210 to 235 net openings, up from our previous guidance of 190 to 220 net openings. And now, I would like to turn the call over to our Founder, Chairman and CEO, John Schnatter. John?

Hey, thanks, Lance, and good morning to everyone. We appreciate each of you taking the time to be with us on the call today to discuss our third quarter results. I want to start off by congratulating our operators throughout the world on achieving one of the best overall quarters in the Company's history. From a sales point, to unit openings, to EPS growth, this was one of the most solid, fundamentally sound, and well rounded quarters I can recall. Let me first comment on the momentum we are seeing from a sales perspective. Our North America operators posted a category leading 5.3% positive comp sales performance during the quarter with franchisees at 4.9% positive, and company owned units at a very strong 6.3% positive comp sales. Our international operators also posted a very solid 4.7% positive comp sales growth during the quarter. Papa John's quality continues to resonate with the consumer, and we are thankful for our strong brand position, which allows us to get a little bit more for our pizza, in what continues to be a very competitive operating environment.

During the quarter, our quality message was also supported by heavier media and more continuous national brand presence resulting from the National Marketing Fund agreement which we put in place in our system last year, which we discussed on our previous calls. In response to these strong sales results, we are again increasing our expectations for 2011 North America comp sales to a range of 3% to 4%, our second such increase this year. On the international front, we are also increasing full year comp sales guidance for again, the second time this year, to a range of 3% to 5%.

Now, let me turn to our restaurant growth story. We continue to see momentum in store growth both in the US and abroad. As Lance said, during the quarter we had 47 net worldwide unit openings bringing us to a total of 134 net worldwide units open for the first three quarters of 2011. We are raising our projected full year 2011 worldwide net openings to a range of 210 to 235, as fourth quarter is historically our strongest for unit economics, and unit openings, to that point. Today, we are on top of 3800 restaurants in 3200 countries, and as we continue to grow the Papa John's brand throughout the world. Moving into the future, our development pipeline is extremely strong with agreements in place to open 1650 restaurants throughout the world. 410 in North America, and 1240 internationally, most of which are scheduled to open over the next six years. Finally, as Founder, I'm gratified by the tremendous pride I continue to see from both our franchise and corporate operators in the areas of demonstrably better product quality, superior quality customer service, and a fantastic job on image.

In summary, pride and momentum equal growth. This formula is serving us very well as we continue to grow scale, and execute against our long term plan for growing Papa John's throughout the world. And with that, I'll turn it back over to Lance for questions. Lance?

Thanks, John. I believe we're ready for questions.

Thank you.

(Operator Instructions)

Our first question is from Chris O'Cull from SunTrust. Your question, please?

Thank you, good morning. My first question related to sales volatility. I don't know if this is for Lance or Andrew, I'm trying to understand why the first and third quarters had such strong comps, especially compared to maybe the second quarter. And I'm just curious if these quarters had heavier ad weights, and if we should see that should continue?

Chris, this is Andrew. Great question. I would classify the three quarters this way, is that we obviously got off to a very fast start in Q1 coming off very strong momentum from P11 and P12 of last year, which helped our first quarter nicely. In the second quarter, as we talked to you all last time about we really put a lot of emphasis on our pricing and making sure that for the quality product that we provide to consumers, that we were getting a little bit more for our pizzas.

So, that just doesn't happen overnight and the second quarter was really focused on making sure that we solidified a premium price point and we've done that. Third quarter, you're right on one front, we were able to cover up a few periods with national TV weight that we didn't have before, so that helped. But I just think executing our plan at a slightly premium price point over what's now 6.5 months has really been effective for us. So, I think you're seeing while you would have a very strong first quarter slow down a little bit in the second, and then pick it right back up in the third.

Is there any reason to believe you can't continue with that pricing strategy with Pizza Hut running the $10 Any Pie?

Obviously, we factor in a number of different variables when we look at pricing, the competitive environment being one, the economy being another. I can just tell you that our goal is to always get the right price point for our quality product that we believe we deserve, and I can tell you, as you would imagine, pricing is the one thing we keep our closest eye on. So we're steady as she goes right now and feel good about things, but like I said, we're always evaluating it.

And then one other question, Lance, what are expectations for the franchisee incentive program for the fourth quarter? Are there certain same store sales or performance triggers you can share for us to help us maybe model the other general line a little better?

Chris, most of the incentives that we have are up netted out in the royalty line. As you're aware, all the things that were put in place when we did the National Marketing Fund agreement at the beginning of the year. We did run a couple of one off incentives in the third quarter, but we don't disclose or we're not going talk about if we'll be doing any of those kind of things in the fourth quarter. I do think that we'll let you know if we see a major change in the guidance, but otherwise I wouldn't look for anything real unusual there.

The third quarter was an unusual situation?

I would say the third quarter was a little bit higher than usual but that's all the detail I think we should go into.

This is Tony. One thing we've -- I think we've commented on before, too, just to reiterate, we're going to be very strategic and deliberate about when and where we use incentives for both the unit economics as well as just working, continuing to drive our strategy.

Great, thanks.

Thank you. Our next question is from Peter Saleh with Telsey Advisory Group. Your question, please?

Good morning. Thanks. Congratulations on a great quarter. My question is on the net unit openings. So it looks like you took them up maybe 20, 30 units on the high side for the year. What really changed? Is it less closures? Or is it more openings, and what's changed from last quarter in terms of your visibility?

Good morning, this is time Tim O'Hern. I would say two things. One, we've got less closures. That is just plainly obvious if you look back to the data year over year, we're having less closures. I think that's attributed to our good unit economics, in some of the things we are doing. The other thing is we're seeing an increase in our pipeline in terms of stores, and the incentives that we have out there are driving our existing base domestically to open stores, and we're getting some good momentum now internationally to help increase our gross number.

Great. And then in terms of the NBA, it seems like right now, they're still in a deadlock. Do you think there could be any impact to your business at all if the NBA season doesn't happen.

This is Andrew. It's a great question. Obviously those are pizza eating occasions when the NBA games are playing, and we have some team rights, just a handful of them across the country, so we're looking at ways to be able to still leverage those team rights for positive sales even while the NBA is locked out. But we're really not going to be able to know until we get into a few weeks of this to see what the impact is, so it's probably something we ought to comment more as we get into next quarter.

Got it. And can you just give us an update on the percentage of sales coming from mobile and online?

Peter, this is Lance. As you're aware, we don't give specific online guidance. What we can say is we're now north of 30% online, so we feel good about that, and when we look at that, we actually, I should say digital, because that incorporates everything. I'm not going to break it down any further than that though, right now.

Would you say that's helping you on the labor line?

This is Tony. I think the primary focus for us on that, and the way we look at that is the customer and consumer experience. That's been the primary focus all along on our digital marketing efforts.

Great, thank you very much.

Thank you. Our next question is from Mark Smith of Feltl & Company. Your question, please?

Hello. First off, could you give us any insight into your outlook for commodities going into 2012?

Hi, Mark, this is Lance, we will be giving our guidance in December, and we'll talk a little more about 2012 commodities at that point.

And this is Tony, and in general, I think we're right now, just kind of very long, long view at least from this vantage point into 2012, we're expecting them to remain high. It's probably a good, I guess, conservative view, given the way the markets have been performing, and all the consensus data that we have today.

Okay. Then second, can you guys just comment on kind of your view of franchisee health? It looks like the pipeline is coming up which is a good sign. Maybe if you can tell us how many of the restaurants in the pipeline are from existing franchisees, if you could give us some sort of gauge? And then secondly, just looking at a recent bankruptcy with a franchisee, is there anything that's positive or negative affecting your franchisees?

Mark, this is Lance, thank you. As far as the bankruptcy goes, that was an isolated incident. We think the health of our system is strong. I'm going to let Tony speak to the first part of your question, though.

We're constantly evaluating the health of our system, and actually talking with our franchisees very frequently, as a senior management team. We're out in the field, I know from a North American standpoint, literally out with our franchisees 4 times a year. So, we're spending a lot of time on the road, in our restaurants talking to franchisees in small group meetings, and really getting a pulse for what's happening at the store level, and making sure we're well connected to our model. And obviously we track performance of our metrics of our franchisees and their financials, and our model is sound. It's strong. And as we also articulated earlier, talked about the incentive plans that we have used historically to -- where we need to, and we're very deliberate and strategic about how we utilize those, but overall, the health of our system is really strong.

Yes, Mark, this is John. We just had one of the best quarters in history. We're having one of the best years in the history on our corporate restaurants, so the franchisee, this particular franchisee, we did everything we could to help this franchisee, but sometimes, some folks won't help themselves, and in this case, we're having a great year. The franchisees that are engaged, and working hard, they are having a great year, too. And that's what we want. We want folks engaged. We want them to be successful, and we work very hard, in Q2, the food service didn't make the margin because we were pushing dollars out. In Q3, we were pushing incentive dollars out, so we do everything possible to make sure our franchisees' unit economics are healthy. Because it's our best interest if their unit economics are healthy, they make money. If they make money, they build more stores.

Is there anything that you would say on that particular franchisee, and what may happen with those units?

This is Chris Sternberg. Right now, the franchisee continues to operate the restaurants. They're in bankruptcy and reorganization, Chapter 11, and so our goal is to keep those restaurants open, and the bankruptcy proceeding will have to play out, but again, our goal is to keep the restaurants open whether that means another operator comes in and buys those stores. We do think our model works in the hands of the right operators, so we'll just have to keep you posted on that as the bankruptcy proceeding unfolds.

Would you be opposed to -- I know you've done kind of buy and build in the past. Is this a scenario that maybe could make sense to take in as company operated?

I don't think at this point, Mark, we'd want to comment on that. Again, we got to let the reorganization process work, and so we'll look at multiple scenarios as that process unfolds.

Okay. Great. Thanks.

Thank you. Our next question is from Charles Temel of UBS. Your question, please.

Good morning, gentlemen, John, Tony, Chris, Andrew, Lance, Tim. Congratulations on really, a fabulous quarter. I have two questions. Number one, in what was really a difficult quarter for everyone and screaming headlines and all the doom and gloom that went on this past quarter, what made it possible for you to be so close and do so well when everybody else faltered?

Charles, this is John. You've known me for a long time, and you don't have great quarters just because you had a great quarter. It's all the things you did the year or two or three before that built up and you put it all together, and you have a great quarter. I would say from a value point of view as far as our values, our principles, the Papa John's scaffolding, our philosophy, I think this leadership team buys into the Papa John's way as good as any management team that we've ever had. Bottom line is, if you do it the Papa John's way, and again I've known you since we went public, since '93, it's a winning formula. It's when you get off the scaffolding and the values, that sometimes you get your hand slapped.

But we've had this kind of really good operations and momentum and execution now for -- it's been in place now probably for three or four quarters and we're just reaping the rewards of doing step by step of slowly chipping away at this thing process. We're going to be consistent. You're not going to see a lot of spikes. We're going to grow the store build methodically, we're going to grow our business methodically, we're going to grow our EPS methodically. We're just not going to jump around, and do anything that's like a heart monitor. But I would say, this management team, this leadership team really buys into the Papa John's way, and as you can imagine, that makes life really easy on me.

So, John, knowing how disciplined, you are, I know that when you were approaching 1,000 stores, you were already thinking about 2,000, and 2,000 you were thinking about 3,000, and now you're at a number -- what is your vision going forward in terms of the potential out there for the Company? What are you thinking ahead now?

I haven't seen -- as I stated in other calls, I haven't seen this kind of team work and momentum and pride since the run we had in 1995, 1996, and the problem in 1996, 1997, Charlie, is we didn't have a measurement system in place to measure product quality and service, so we had the marketing position in better ingredients, better pizza, but we weren't supporting it with our fundamentals and that's why we lost momentum in 2000 to 2002. In those years, we put in a mechanism by which to measure customer experience, and our fundamentals got better, and so, since 2006 and 2007, we've had a nice a little run. We will cross -- specifically to answer your question, we will cross store 4,000 first or second quarter of next year, and we've got 1650 stores in the pipeline. The next step is 4500. The next step is 5,000. As you know, this is a scale game. We've never been in any market throughout the world where once we get scale, and we get on top as the leader that we don't stay the leader. So from here on out, it's a scale game, and we're going use our healthy balance sheet, and our strong balance sheet, to build restaurants and to achieve scale.

Thank you very much. And again, congratulations.

Thank you.

(Operator Instructions)

Our next question is from Brad Ludington of KeyBanc Capital Markets. Your question, please?

Hello. John, I want to start off with the lobby redesign initiative. I think last quarter you said that was over 1,000 units, maybe going on 1100. Is there any update on how many have that now, and how many you think will get it in the full year?

The overall acceptance of the lobby enhancement has been very good. In fact, I don't think we've had any push back on that. There is a little bit of a push back on the dollars. But we've put a program in place to help finance that. All the new stores, of course, throughout the world have the new lobby look. We just went around the world about 40 days ago and, again, as a Founder, I'm delighted that the stores in Chile, stores in China, stores in Russia, all look like the Papa John's way. Tim, you want to talk specifically about how many have actually been remodeled?

Sure I do. By the end of the year, we'll have all the corporate stores that needed to be updated, which I believe was around 400 to 450 that needed to be updated. Those will be completed. As a matter of fact, I think that number is down under 50 now that needed to be done. The franchise system, as John indicated, has bought in very well. We continue to see that number chipped away at on a monthly basis. I think we started at around 1300 stores or so, and I can't give you real specifics on that, but we continue to chip away at that, and I think over half of those have been ordered. Wouldn't want to be very specific on that because I don't have the number right in front of me. But as John indicated, it's going well. There's been very little resistance to this, it has been accepted well by both the franchisees, and the customers in terms of feedback, so it's a good program.

Okay. Thank you. And then, on the franchisees getting incentives, I know you don't want to give color on maybe what you're going to do in the next few quarters, but two questions, on the point of modeling that, Lance, should we expect that if you're doing that in a given year, it would probably be weighted more to the back half of the year in the third and fourth quarters?

Brad, I think probably the -- we're going to continue to do incentives, take advantage of our balance sheet, do the things we need to do to drive the business. I'm not sure I'd look for any specific weighting. I'm not sure we're even able to guide at that level right now from a quarter to quarter standpoint. I would just tell you that we are going to continue to invest in our system, and make sure our system stays healthy as long as we feel like we need to be doing that.

And Brad, this is Tony, we really honestly just want to be as flexible as we can with that. And that's what we communicate to, you know, to our franchisees and we're very deliberate about when and why we do it.

Okay. And Lance or Tony, I don't know if you're open to talking about this part, either, can you comment on what percentage of franchisees got those incentives in the third quarter?

And we wouldn't want to share that, Brad. I appreciate the question, but wouldn't want to disclose that.

Okay. Fair enough. And then what about maybe trying this way, I know I'm digging for some information here. Regionally, one of the things that the last couple of years that you were working towards, and I think said you had good progress in, was improving performance in emerging markets, which had been lagging in the tough economy. How are those emerging markets doing versus established markets these days?

Brad, this is Lance. I think what I would tell you is we feel like our system throughout North America is healthy. So, I don't want to hone in on a particular city or a particular market other than to tell you, with the strong results we're seeing, you can tell we don't have too many markets that are dragging us down.

Yes.

I feel like we're in pretty good shape. The other thing I'd like to point out, on the incentives we do, on the royalty incentives, they were part of the National Marketing Fund agreement. You will see those continue through 2012 and 2013, so realize those are netted in the royalty number but will be ongoing for at least two more years.

And then finally, what about average check? Was that positive or negative this quarter?

As you're aware, we don't disclose the difference between our ticket and our transactions.

It was worth a shot.

You're trying hard, Brad.

I know. Getting shot down everywhere. Congratulations on a great quarter and thanks.

Thanks, Brad.

Thank you. I'm showing we have a follow-up question from Chris O'Cull of SunTrust. Your question, please.

Thanks. I had a question regarding the commissary. Would you all give us an update on your pricing strategy at the commissary? It appears you took some pricing in the third quarter.

Chris, this is John. I kind of want to answer Brad's question in a fair way, and I know that you all have to look at the business quarter to quarter, and we do, too. We really do. But we probably look more at it on a yearly basis and probably even more heavily on a two or three year basis. So it's not like last quarter was the highest commodities I think we've had in our history, but we had our best quarter. And so, the commodities jump around, the competitiveness -- remember, our competitors are good at what they do, and they're big, and so, you don't know what they're going to do next.

So there's more than one ball we're juggling here to produce the results we're producing. And I'd say the thing we're trying to do is produce consistent earnings growth in kind of an inconsistent world. And that's what we're trying to do, and we've got a lot of levers to do that by. We've got now national marketing 12 months out of the year, we've got this electronic and social media advantage that we deploy quite well, I might say. We have the commissary, which from time to time we actually lower margins, and so we're always moving different levers around basically on a daily basis, to try to produce predictable earnings in an unpredictable world.

But you can't do that looking at the business on a -- I know you all don't like hearing that from me, but I look at the business over a long period of time. You can't run this thing just trying to make the quarter. Are we excited about Q3? Heck, yes. Was Q2, could it have been a little better? Sure. Was Q1 great? Yes. But if you live your life quarter to quarter, it's going to be a pretty up and down life, versus we look at the thing, okay, where is this thing going to be in six months, nine months? And if we feel good about that, and the quarters fall in place, then we have a pretty good feeling about the business.

That's fair.

Chris, this is Lance, just to jump in also on the question relative to commissary pricing. We didn't actually take pricing in the third quarter. We have a fixed markup on cheese, which is a big part of what we sell, so when you see block cheese up over $2 like you did in the third quarter, it's going to drive our revenue numbers up. So that I think is why you're seeing some of those increases in food service revenues.

Volume was up as well.

Our volume was up as well. So, it wasn't that we're necessarily making more as just the cost inputs were higher, and we got a fixed markup.

And that was really the basis of my question. I was trying to understand if the dollar margin, had the markup changed at all, or whether you -- in terms of non-cheese items like fuel, and some other proteins.

Well, Chris, as you know, we manage our commissary system in such a way to keep our entire system very healthy. And so we're managing well within the guidelines that we've set with our franchisees as to how we're going to manage the business, and it may swing by a few points here and there, but generally speaking, we haven't made any long term changes. Tony, do you want to address any of that?

This is Tony. We manage that by the quarter from a pricing standpoint, and of course looking at the overall full year window.

Okay. Great. Thanks.

Thank you. I'm showing no further questions in queue at this time. I would like to turn the conference over to Lance Tucker for any further remarks.

I want to thank everybody for your time. Thank you very much, and we'll be announcing our guidance in December. Have a good day.

Ladies and gentlemen, thank you for your participation. That concludes the webcast. You may disconnect, and have a wonderful day.