Papa John's International Inc (PZZA) 2013 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Papa John's fourth-quarter 2013 conference call and webcast.

(Operator Instructions)

As a reminder, this call is being recorded.

I would now like to introduce your host for today's conference, Lance Tucker. You may begin.

Thank you, Tom. Good morning.

With me on the call today are our Founder, Chairman, and CEO, John Schnatter; President and COO, Tony Thompson; SVP of Global Operations, Steve Ritchie; and other members of our senior management team.

After a brief financial update, John and Tony 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.

All forward-looking statements should be considered in conjunction with the cautionary statements in our earnings press release and the risk factors included in our SEC filings. All statements made on this call are as of today and we undertake no obligation to update the information on this call in the event facts or circumstances subsequently change.

In addition, certain financial measures we use on this call 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. Unless otherwise noted, all comparisons are versus the comparable 13- and 52-week periods from a year ago.

This call is being taped and the replay will be available for a limited time on our website and in downloadable podcast format. Finally, we ask any media to be in a listen-only mode since this is primarily an investor call. Now on to a discussion of our fourth-quarter and full-year operating results.

For the fourth quarter, our diluted earnings per share were $0.41, up 32% versus 2012. Our full-year 2013 diluted EPS was $1.55, an increase of 20% versus 2012. Our fourth-quarter revenues increased 12.2% versus the fourth quarter, excuse me, of 2012. Driving the increase were comp sales of 9% for North America and 7% for international, as well as a 6.4% increase in the number of units operating globally on a year-over-year basis.

The North American comps and increased unit count also drove higher PJ Food Service revenues. For the full year, revenues increased 8.9%. Again, these results were driven by strong comps of 4% in North America, 7.5% for international, an increase in global units, and the increase in PJ Food Service volumes.

We opened 132 net global units in the fourth quarter and 265 net global units in 2013, of which 183 were international and 82 were in North America. On a business segment basis, operating income for domestic Company-owned restaurants was up over $600,000 in the fourth quarter. Incremental profits from our 11.5% comps were largely offset by lower gross margins, due primarily to higher commodities and lower national promotional pricing, as well as increased restaurant-level bonuses.

For the full year, operating income for domestic Company-owned restaurants was down $900,000 as 6% comp sales were more than offset by higher commodity costs. Operating income for the North America franchising segment increased approximately $1 million in the fourth quarter and $2.3 million for the year, due primarily to the increase in net units and comparable sales of 8.1% in the fourth quarter and 3.1% for the full year.

Operating income for our domestic commissary business segment increased by approximately $4.4 million in the fourth quarter and $4.7 million for the year, due primarily to the incremental volumes associated with higher restaurant sales for both periods. Operating results for our international segment decreased approximately $800,000 in the fourth quarter as higher royalties associated with 7% comps were more than offset by higher losses in our Company-owned China restaurants, as detailed in our press release and 10-K.

For the full year, operating income for international is up approximately $150,000. As with our quarterly results, 7.5% comps were largely offset by higher losses in our Company-owned China restaurants. Unallocated corporate expenses improved approximately $900,000 in the fourth quarter and $2.2 million for the year, due primarily to lower legal costs and lower short-term management incentive costs.

Our effective tax rate was 29.4% in the fourth quarter and 31.2% for the full year, down 1.3% and 1.7% from prior-year periods. Our effective rate may fluctuate for various reasons. The lower 2013 tax rates included higher levels of credits earned and the one-time settlement of specific state tax issues. We repurchased approximately $49 million of stock during fourth quarter and $118.5 million during the year.

The Company has approximately $110 million of remaining share repurchase authorization. Our free cash flow, a non-GAAP measure we define as cash flow from operations less capital expenditures, was approximately $51 million in 2013. Our net debt position, defined as total debt less cash and cash equivalents, was $144 million at year end.

As detailed in our press release, the Company also released 2014 guidance. Highlights include the following, diluted EPS is projected to be in a range of $1.64 to $1.72 per share, including approximately $5 million, or $0.08, of higher costs relative to 2013, due to implementation of our new FOCUS POS system. Excluding the impact of FOCUS, this represents an 11% to 16% increase from 2013.

North America comparable sales are projected to range from 2% to 4.5%. International comparable sales are projected to range from 5% to 7%. Pre-tax income margin is expected to increase 20 to 40 basis points, excluding the impact of FOCUS, due mainly to projected improvements in international profitability, including improvements in our Company-owned China market.

Worldwide net unit growth is projected in a range of 220 to 250 units, of which approximately 70% are expected in international markets. Income tax rates are expected to return to more historical levels between 32.25% and 33.75%.

Please see yesterday's press release for additional guidance items. And now, I'd like to turn the call over to our Founder, Chairman, and CEO, John Schnatter. John?

Thanks, Lance, and good morning, everyone. We're glad you're able to join us this morning as we discuss our fourth-quarter and full-year 2013 results. I'd like to start out by congratulating our franchisees and operators throughout the world for an outstanding fourth quarter and an equally impressive 2013.

In the face of increasing competitive pressure throughout the year and a global economy that is still struggling to gain its footing, our global system continues to excel at the fundamentals in delivering on our Better Ingredients, Better Pizza brand promise throughout the world. That focus resulted in North America comp sales of 9% for the quarter and 4% for the full year, representing the 10th consecutive year of flat or positive comp sales.

On the international front, that focus led us to 7% international comp sales for the quarter and 7.5% for the full year. It also led us to a strong EPS increase of 10.8% for the quarter and 20.2% for the full year. Our 2013 accomplishments are the direct result of our exceptional management team led by Tony Thompson and our world-class operations team led by Steve Ritchie.

As you know, we've spend a great deal of time and money each year to ensure our restaurants are making good and delivering the industry's highest superior quality pizzas with world-class customer service. As you can see, that investment continues to pay off. Our quality and service scores were higher than any year in recent memory, which led Papa John's earning the highest rating in the prestigious American Customer Satisfaction Index for the 12th time in the last 14 years.

It also led to the fifth straight year of pre-tax income growth in our North America franchise segment. Having founded the Company 30 years ago with an unwavering commitment to quality, it goes without saying that I'm very pleased with the results we continue to produce by executing the fundamentals. Satisfied customers lead to more loyal customers, and loyal customers lead to more profitable franchisees who want to grow their business.

It also leads to new franchisees entering the system who want to partner with a winner and want to be part of something special. To that end, I'm also very pleased with the restaurant growth numbers during the quarter and the year. We opened up our 1000th restaurant out of North America -- outside of North America, and finished 2013 with 1142 international restaurant open in 35 countries and territories.

Today, we are approaching 4500 restaurants globally with a strong global development pipeline with agreements in place to open approximately 1200 restaurants over the next six years. I'm very excited about the future of our brand worldwide.

Our global footprint continues to expand in large part because of the solid progress we continue to make internationally in our store operations and our overall approach to the business. Strong performance in the UK, where we were able to successfully leverage our official pizza sponsor of the football league in the United Kingdom, along with continuing momentum throughout much of the world, including Russia and Latin America, helped drive our performance and positioned us for future success.

I would like to conclude by commenting briefly on our marketing and branding. And in 2013, we enjoyed another solid year as the official pizza sponsor of the NFL, and did a better job than ever in activating that sponsorship.

In fact, in a recent survey conducted by Street & Smith business report, 41% of the respondents identified Papa John's as the best activating around NFL. That's higher than any other sponsor, including well-established brands. Additionally and overwhelmingly, 62% named Peyton Manning as the face of the NFL. We are confident that our NFL sponsorship and our partnership with Peyton Manning, who you will recall is also a franchisee with 25 restaurants in the Denver market, will continue to pay dividends for the brand for years to come.

I am proud of our team. I'm proud of our momentum. And I think we had a great quarter and a great year. With that, I'll turn it over to Tony Thompson for remarks. Tony?

Thanks, John.

I would also like to start by congratulating our system on a tremendous quarter and year. In addition to our solid operations and execution of the fundamentals, when I look back at 2013, two areas in particular stand out: our digital leadership position and the strengthening of our LTO pipeline.

We continued to extend our technology leadership position in 2013 by becoming the first national pizza company to have more than 45% of domestic system sales coming to our digital channels. In doing so, we topped the $5 billion mark in all-time digital sales during the year. We are well on our way to becoming the first national pizza chain to achieve a domestic system-wide digital sales mix of 50%.

Let me repeat that. We are well on our way to becoming the first national pizza chain to achieve a domestic system-wide digital sales mix of 50%. This is the latest in a long list of technology firsts that continue to keep Papa John's in the lead digitally in the pizza industry.

Among others, Papa John's was the first national pizza company to offer system-wide online ordering in 2001. We were the first to offer system-wide text ordering in 2007. And we were the first and still the only pizza company with a system-wide digital loyalty program, Papa Rewards, which launched in 2010.

Our digital leadership continues to play a vital role in moving the needle for our brand, both in terms of sales and customer satisfaction. In addition, our technology leadership continues beyond consumer facing innovation to back-of-house initiatives, such as our new point-of-sale system, that we will soon begin to roll to our domestic restaurants. The new POS system, which we call FOCUS, is a technologically advanced system designed specifically and uniquely for our model, and will support continued store level productivity and profitability.

In 2013, we also invested in a fully automated dough production facility at our current distribution location in New Jersey. This state-of-the-art quality control center is now producing our fresh dough and distributing other high-quality ingredients for our restaurants in the Northeast more efficiently, and is better able to support our continued growth in that region of the US.

Now turning to our LTO pipeline. In 2013, we introduced some exciting LTO products from a very robust pipeline. Our 2013 lineup included our award-winning buffalo chicken pizza, which won the Nation's Restaurant News MenuMasters Award for best LTO pizza, our chipotle chicken and bacon pizza, and a new delicious complementary side, our mega-chocolate chip cookie, that continued to be very popular with consumers.

Our LTO offerings in 2013 have served as a springboard for introducing more high quality and innovative products in 2014, including our double cheeseburger pizza, which is our latest and current offering. The double cheeseburger pizza continues to be very popular with consumers, and at a $12 national price point, proves again that consumers are willing to pay a premium for quality.

On the branding and marketing front, this week we announced that we have selected Grey as our national advertising agency of record after a search process that included 17 different agencies. We have challenged Grey with evolving and freshening our TV creative, and fully integrating digital advertising and social media as part of our 360-degree marketing approach.

The entire executive leadership team was impressed with Grey and the creative direction they developed for the brand, that leverages our quality leadership position. We believe our partnership with Grey will continue to elevate the brand and help us achieve our next level of growth. And with that, I'm going to turn it back over to Lance for questions.

Thanks, Tony. Tom, I think we are ready for questions.

Absolutely.

(Operator Instructions)

Our first question comes from the line of Michael Halen from Sidoti.

Good morning and congrats on a very strong year.

Thank you.

Can you speak about some of the -- you're welcome. Can you speak about some of the efficiencies the new POS system will create in the restaurants?

This is Tony, Michael. At this point, we are not prepared to provide a lot of color around efficiencies and ROI and details of that nature. As you know, implementing a change like this across 3600 restaurants with the intent of being largely complete by the end of this year is not a small undertaking.

Just the change management process, training, et cetera, will be something new for our operators. But along the way, we will provide information as it warrants.

Hey, Michael, it is Steve. Maybe I will provide a little bit of color there. To Tony's point, don't want to try to quantify anything in terms of return on investment, but what I will say is we invested into technology 17 years ago with our PROFIT system, as we call it.

Not a significant change in terms of software, but a significant change in terms of hardware. We are moving to touch screen technology, which will drive efficiencies in terms of speed and accuracy on order entry. We're also -- we have state-of-the-art labor management system and we also have state-of-the-art driver dispatch system. Those things, comprehensively, will drive efficiencies in our business in the long term.

Okay. Thank you. In terms of the quarter, with such a strong comp, I was surprised about the lack of operating leverage in the quarter. Can you give some more color, maybe which commodities caused the most pressure? Any color you can give will be helpful?

Hello, Michael. This is Lance, I'll start with that one. Really the commodities situation, cheese wasn't much of an impact on the quarter. Really we saw some more in the meats, dough, and boxes. I'm not going to give you exact amounts there, but cheese was relatively neutral. It was the other items that drove the cost up a bit.

All right. Great. Thanks. And then just one more quick question. What are your assumptions for commodity prices and foreign exchange that are baked into the 2014 guidance?

I will start with that and this is Lance. On foreign exchange, that for 2013 was still a relatively small number and we expect it to remain relatively small in 2014. I would say negligible on that front. Relative to commodity costs, we are seeing flat to up 1% for our commodity basket.

And certainly, you can see what is going on with cheese right now, with futures well over $1.90 and the spot price approaching to $2.20 again after it had come down a little bit. What I would tell you is, from a cheese standpoint, we have mid- to high-$1.80s built in. If cheese stays where it is, as I'm sure other folks are telling you, we will reassess as we go.

Great. Thank you very much. Thanks, everybody.

Thank you.

Your next question comes from the line of Peter Saleh from Telsey Advisory Group.

Great. Thanks. Good morning. I just wanted to ask on the comp trajectory, so on a one- and two-year basis, domestic system-wide same-store sales accelerated pretty significantly. And just curious if you could just talk about some of the things that happened in the fourth quarter?

You had the mega-chocolate chip cookie, which was different from last year, Thursday night promotions with the NFL, which was also different from last year. If you had to rank order the real drivers of the acceleration, how would you rank order those?

Peter, this is John Schnatter. To your point, the two-year comp increase is, for the system is 7.6% and the three-year is 11%. And the three-year, interesting enough for the corporate restaurants, is 16.3%, to your point.

I'll hit Peyton and then turn it over to Tony and he can give you a little more detail. Peyton has been a big part of our success. He's a simple, humble man, so I'll keep my comments with regard to him short and factual. In the fourth quarter, we actually had a larger competitor who spent three times more money than we did, who also has a professional NFL quarterback, ran negative 4%.

Papa John's and Peyton Manning in the same quarter spent 1/3 as much as ran a plus 9%. We're very keen on the association and the success we're having with Peyton. When we got involved first off with Peyton Manning, the market cap of Papa John's was $900 million, today it's over $2.2 billion. And I got to tell you, any company organization that has an opportunity to get involved with Peyton Manning and/or the Manning family should jump all over it. Tony?

Thanks, John. And, Peter, this is Tony. Fourth quarter really was a composite of a lot of things. Not any single one thing. It is really the continued momentum from prior quarters as we continue to talk about.

But first and foremost, our continued excellence in execution from our operations team. And John mentioned in his opening script, we have very sophisticated measurements on the quality and service and we are continuing to break records on that. And that's what it is all about. We're Better Ingredients, Better Pizza, so our product and services is a foremost focus for us.

We had some really compelling offers during the quarter, which I'm sure you are aware, and it's still a very competitive price environment. We had some new innovative creatives in the fourth quarter. I'm sure you saw some of our commercials taking a little bit of a different approach.

We had some very strong LTOs all throughout the quarter, and then from a menu enhancement standpoint, our new complementary side with our chocolate chip cookie, also it was accretive and just another positive product for us in our menu. And then, finally, back to John's point on our NFL partnership, we just continued to get stronger with that partnership and how we activate it, and they are great partners. Steve, comments?

Yes, Tony, and I'll just touch on them. I think touching back again, as John talked about, the two- and the three-year comps on an annual basis, if you look at the two- and the three-year comps on a quarterly basis, the corporate side of the business was up 18.4% in two-year comps, and almost 20% on a three-year basis. And the franchise not far behind.

It's just, again, demonstrating in the fourth quarter, our sponsorship with the NFL is playing a key part of that from a national perspective. But we should also mention we are very comprehensive from a local to a nation, so we now sponsor over 19 teams in the NFL. And all the resources that we have the leverage to drive that, and as Tony had spoke to before, in our leadership position and digital.

So the activations that we apply to those sponsorships at the local level are continuing to drive real market share gains for us in our business.

Is there any reason why this momentum shouldn't carry over into the first quarter of 2014?

This is Tony. We certainly expect continued momentum as a whole, but as you can see from our full-year guidance that we put together, we're looking at -- we provided that in the context of a full year, not a specific quarter. We are not going to give any real color detail around Q1.

It is all about just consistency has been a key message for us over time. And the team is focused and we are going to consistently deliver.

Great. And then, quickly shifting gears to international, will we get to China profitability in 2014?

Peter, this is Lance. I will start with that and let the others jump in. We're not going to put an exact time frame around when we are going to hit profitability in China.

What we can tell you, and then I will hand it over to Tony or Steve or John here, is that it takes a while to build out a big market, as you've heard John say before on prior calls. And we are making progress, and we feel good about China long term. I will let you guys jump in there.

John?

Peter, this is John Schnatter. There's nothing happening in China or anything internationally that we did not experience in the US. I mean Atlanta and Dallas, the big markets, L.A., always take a little bit more time. Even though we don't like it, it's pretty predictable.

And back in November, as Lance mentioned, I also spoke about how we're very, very consistent. And we think that consistency is what makes us strong over the long term. I can tell you the competitive advantage we have and the demonstrable difference we have in our product and our marketing in the US is actually exacerbated worldwide.

In other words, the difference between us and our competitors on product and image worldwide is even stronger than it is in the US, because we've spent the money and we've taken the time to implement consistencies through the gold standards on both marketing and the product. And I think that's applicable to China. Tony?

Thanks, John. And a few comments, Peter, on China. We are investing for the long term. And I know we say that on these calls probably quite a bit. We are very long-term focused, and we are also focused on success.

We go in and we know it is going to take some time. It is going to take us some investment. And we have a balance now in Beijing of delivering carry out plus full-service restaurants. That is a little bit new territory for us.

We knew that going in. But we also were investing in the right things from a digital standpoint. We just launched our online ordering system in China in January. That's part of some of some of that infrastructure investment that you are seeing.

Yes, Peter, this is John again. As we have talked in the past, the quarters will bounce around a little bit. But over a yearly basis, as long as the momentum and the direction of the business are on the right vector, we will be fine.

Yes, Peter, I'll just put one more closing comment to them. I think what I would call China in 2013 is a foundational investment year, really to develop a springboard into 2014. Although we don't want to quantify exact timing in terms of profitability, what you can expect is significant profitability improvements in China in 2014 to build momentum for the long term.

Great. And then just on the unit growth side, the 220 to 250 global net units, it seemed a little low to me. Can you just talk about what is going on with franchisees domestically? It seems like the international number may be similar to what you put up in 2013. Any reason why we're not seeing an acceleration in new unit development?

Peter, this is Lance. I will start here again and hand it off. But we provided guidance that we feel, based on what we know today, is the best range and our best estimate of the range. And certainly, if that needs to change it will as we get further into the year. But we are very comfortable with where we are for now.

Yes and, Peter, I would just say again, and we're very repetitive on what we say here, but I think the key thing for us is strategically providing balance. We don't want our investment and our build-outs to outpace the infrastructure and move away from overall our strategy of what we do from a brand standpoint. So feel comfortable with the to 220 to 250, and continuing to provide that kind of growth that we are looking for going back to our EPS guidance.

Great. Thanks. I will hop off and maybe hop back in the queue.

Thanks, Peter.

Our next question comes from the line of David Carlson from KeyBanc.

Hello, guys, I hope everyone is having a great morning. A couple of quick questions and then I have a follow up. How much did promotional activity help comp during the quarter?

And can you help us understand, as a follow up to that, how you balance gaining market share without potentially risking cheapening the brand through discounting, and eroding the supreme in position that you guys have worked so hard to convey to the public?

Hello, David. This is Bob Kraut, CMO. And one of the things we are doing for 2014 is consciously putting forward a strategy to maintain our premium pricing by reducing pass-throughs and reimbursements in the form of discounts.

And investing that in marketing to build the brand, to create a stronger emotional connection, and to get credit and reinforce the benefit to the brand, which would give people both emotional and rational reasons to pay and retain -- pay for the brand and retain more of the net price. The other thing that we are doing is looking at the total spend and being much more aggressive in investing media in the digital and social media arena, in addition to strong, very competitive weight levels in television.

And the answer to that question, I think we are doing a lot to maintain the premium pricing. And as Steve had mentioned, the double cheeseburger, which is a full priced $12 premium price pizza, is very, very popular and a very, I would say it's up there and one of our top performing limited time offers in recent years. What was your second question?

Yes.

Add to the first part for you, have you follow up, David. This is Tony. 2013 for us really was a transitional year. And we are looking at 2014 being more transformational.

If you look at, just segue to some of the things that Bob shared on the promotional front, things that we've pulled away from, we are still in a very competitive environment, value seeking consumers, the economy is still on the rebound, still tough. We recognize that.

How we position are brand, we know we're the premium leader within the category, and we just announced this week a new ad agency that we are going to be working with that is going to help elevate our brand message and reach. We are meeting consumers where they are and make sure that message really, really penetrates on Better Ingredients, Better Pizza.

And we're off to a good start this year to Bob's point, on the double cheeseburger pizza on a price point standpoint. But 2014 we think is a really good opportunity to break away from being viewed in a grouping of pizza restaurants that are typically value and price oriented.

Okay, so the bottom line I think that I -- I'm sorry.

David, this is John. As you may remember, as I stated in the August 7 earnings call, at the end of day the pizza consumer recognizes that you get what you pay for and a $5 or $6 or $7 pizza is really not a pizza that reflects quality. It is just not.

And again, you just can't make a superior quality pizza with superior quality ingredients for $5 or $6 or $7. It's impossible.

David, you had another question or follow up to that?

Well, I think the bottom-line is you guys, the promotional activity we should expect to be down this year from what we saw in 2013, correct?

I think, David, it is Steve. I think what you're going to see is something very similar in terms of our overall strategy. Don't want to get too specific in terms of the pricing related to the promotion, but we're going to stay very consistent with our overall strategy that you saw in 2013 into 2014 in terms of our relationships from a partnership standpoint. And leveraging is what Tony alluded to before, that very robust product pipeline.

And, David, this is John again. I don't see anything that doesn't say that our execution is going to get better, our marketing is going to get better, and our scale is getting better. I don't see anything but good.

And then a follow-up question, given the chief price movements that you guys alluded to several months -- several minutes ago, and that we seen here over the last couple of months staying at these elevated prices, any idea of what we might be looking at in terms of gross margin in the first quarter? And to add onto that, would you be willing to pull back on promotional spending to help protect gross margin?

David, this is Lance. We're not going to give quarter-by-quarter margin information. That is something we stay with. I think the theme you've heard from this group is we're looking at the long term and we're going to do what is right long term for the brand.

And we're not going to make quarter-to-quarter decisions and think kind of short term. I think that is the short answer. I'll let anybody else add on if they would like.

And other follow-ups, David?

I'll just thank you guys, very much.

Thank you.

Thank you.

(Operator Instructions)

Our next question comes from the line of Mark Smith with Feltl and Company.

Thank you. Hello, guys. Can you give us more insight into G&A spending in 2014 with the rollout of the new point-of-sale system? Will you guys be able to leverage this line?

Mark, this is Lance, I will start with this one. As it specifically relates to the new system, again, we're not going to quantify any kind of ROI or any kind of improved efficiencies at this time. In general, as I look at the G&A line for 2014, what we expect is it will be flat, maybe just a little bit up.

And the reason for that, we do have significant IES and international costs that run through that G&A line on the face of the P&L, and we are going to continue to make investments that will solidify our leadership position in technology and allow us to continue to grow international for the long term. Flat to just a little bit up on the G&A line. But most of that is not coming from your traditional corporate office, if you will.

But then when you --

Mark, this is John. We really look at the business from -- we are actually out two or three years in our vision. I can tell you next year, 2015, when we have the call that we are having today, Papa John's will be a better Company then than it is today.

So we realize that we have to hit the quarter, and we have to hit the number. But from a mindset, we are already two or three years out with our Company.

Lance, when you say flat, maybe up, you're talking as a percent of sales?

Yes.

Okay. I'm trying to get into your pre-tax margin guidance of approximately what you saw in 2013. If we're looking at G&A roughly flat, is it safe to assume restaurant operating margins down with some of the cheese and commodity pressure, maybe some labor pressure, but able to really improve the profitability in international and maybe a little improvement in commissary and other?

Mark, what we noted in our guidance and I'd really stick to that, we're seeing 20 to 40 basis points if you exclude focus of margin improvements. And the large driver of that is, in fact, going to be on the international side of the business.

Everything else will be flat to a little up or a little down. But the real meaningful part is going to be coming from international.

And you guys just walked through a lot on pricing and promotions. Can you talk about what you're seeing out there competitively as far as pricing right now with cheese over $2? And is there an opportunity as we see cheese prices higher that maybe some mom and pops shut doors and you guys are able to withstand this pressure a little bit better than smaller players?

This is Tony. There is no question that the larger chains are gaining share at the expense of the regional and smaller chains. And that is, obviously, due in part to share, just as far as share voice, our digital leadership that I talked about, pricing efficiencies, et cetera.

And from a pricing standpoint, you are still seeing some pretty competitive aggressive price points from not only the national players but even some regional chains. And that competitive environment that I mentioned that we have to be sensitive to, as we know we have the quality and premium position, there is just some price elasticity there that we have got to be careful of.

As I mentioned, the double cheeseburger pizza promotion that we are running at now, we are at a national price point that is higher than anybody else. And so, we certainly have confidence as we move forward, we are going to be able to continue to do that because of our position. But I don't want to comment too much on what the competitors are doing. We certainly pay attention to what they are doing, but we manage our -- out of our playbook.

Yes, Mark, this is John. I really feel with our momentum and our positioning and our product quality that we are in the best position to continue with the momentum. And that momentum makes it a lot easier to absorb the higher food cost.

In other words, the worst place you'd want to be in right now is to have to sell pizzas for $10 or less and be running negative. That would be the worst place you would want to be in this environment.

Yes, Mark, and it's Steve, I will add one more thing. I think, without a doubt, this category is all about top-line sales and taking market share, as I alluded to before. If you look at our fourth quarter, one- and two-year and three-year comps, we are taking share.

And yes, we are taking share from independents and the regionals, but it's not hard to dissect the numbers and see Papa John's create a separation in taking share from even some of the national or larger regional chains out there. In terms of being able to sustain some of the pressures from a commodity standpoint and high cheese prices, again, it's all about sales.

Higher average unit volumes are going to be able to continue to push and grow with those independents and regionals that are smaller. Our lower average unit volumes are going to put more pressure and you are likely to continue to see further consolidation within the category and closures of those stores.

This is Tony. One more comment I would like to add just to make sure we're being clear, too, that we historically, we have implemented some pretty aggressive promotions strategically at the right time, because we pay attention to the healthy balance of ticket as well as traffic, to what Steve was alluding to.

From time to time, we will get more aggressive on a particular offer based on maybe what is happening within that particular quarter, again, with a long-term focus in mind by making sure that we are not doing things to degradate our brand position.

Last question I had, I just wanted to try to dig a little bit more into the health of your domestic franchisees? We saw North American net unit growth slightly miss your guidance here for this year. Your guidance is lower for net openings in 2014.

Is there to anything to read into this? Is this more just saturation and not as many markets and stores to open? Or what is the demand from your franchisees to really open new stores?

This is Tony. I will start and then I'll hand over to Steve for comments. First, we monitor our system health very, very closely and very carefully, and have a very, very good working relationship with our franchisees through our franchise advisory council. And that is -- profitability is at the forefront of all of our minds, as John indicated in his script, profitable restaurants and franchisees indicate or mean growth.

That is very, very important. Not only do we have the monitoring approach, but as we are very well penetrated in a large part of the country. And remaining development areas we are seeing, you are not going to end up potentially seeing some of the sales levels at some of the highly penetrated markets that we are in today.

And I think that's just a statement of available market areas. Steve, you want to add anything to that?

Yes. I think you hit it Tony. Mark, it's Steve again. So I think it -- the key piece for franchise health, again, good indications of that franchise health, we tie everything to top-line sales.

So you look at our one-, two-, three-year comps, our three-year comps at nearly 10%, that is a good indication if we're driving top-line growth, we're getting good margins and franchisees are making money. Number two, you look at our unit builds in North America over the last three years. We got a very robust pipeline. Our gross unit openings have been strong. Another indication of franchisees doing well.

With that being said, yes, it has been a very challenging competitive pricing environment, a very challenging economic environment related to commodities. We recognize those challenges and strategically balance everything that we do to drive the business, provide incentives from a development standpoint, and other special incentives to help support those franchisees to ensure they have health.

Without the health of the franchisees, we have no business. And that is certainly a big priority for our brand.

Do you expect any -- we saw some bigger closures in Q3 on domestic franchisees. Is there anything in there that's built into the guidance that you guys see on the horizon?

Mark, this is Lance. We don't have anything big built in. But frankly, we wouldn't share real specifics around that anyway.

That is fair. Thank you.

Thank you.

We have a follow-up question from the line of Peter Saleh from Telsey Advisory Group.

Great. Thanks. Lance, can you just go through the CapEx for 2014 and how maybe that breaks down?

It seems like CapEx will be similar to 2013, but we would expect operating cash flows to be up, yet you are calling for free cash flow also to be kind of similar to 2013. Maybe you can just walk us through the CapEx break down and how we get to kind of a neutral-ish on free cash flow?

Sure. And Peter what I'll do, I'm not give a whole lot of detail, but I will give you a little bit. From a CapEx standpoint, what you are going to see is you're going to see continued store builds in China. You are going to see continued, probably the biggest part of our CapEx is continued investments in the technology side.

We will be rolling out a focused system to our corporate restaurants, that is 650 restaurants. That's all flowing through our CapEx number, as you can imagine. Other technology investments we will be making to make sure we retain our leadership position on technology side. And then good maintenance and keeping up our restaurants, frankly, and making sure that our image stays right at the very top of the category.

I think from a CapEx standpoint, it is very similar to last year. Last year, you had more the development of the FOCUS system. This year, that transitions to more the hardware of the new system in our restaurants.

From a free cash flow standpoint, again, you will see an increase in operating income. And it's just a matter of how some of the working capital items, excuse me, some of those working capital items work their selves through. So we will get better updates on that as we go throughout the year on a net cash flow standpoint.

Yes, Peter, this is John. I think Mark kind of alluded to a little bit of a conservatism in our projections. And with cheese over $2 a pound, and the huge task of rolling out 3600 computers in 2014, we are off to a good start. We are fine with we just finished a P2. A P1, we are off to a very good start.

With that being said, if you could paint the picture in P8 where we had say 1000 of the computers rolled out, cheese was back to $1.80, and we're seeing some improvement because of the technology, that would be a different picture. But we have some work to do here. And we have got work ahead of us. So I feel very good about it, but I think we need to be a little bit cautious with what we've got to get done.

All right. Thank you very much.

Thanks, Peter.

Our last question comes from the line of Alex Slagle from Jefferies.

Thanks. A question on the international franchise revenue royalties and fees in the fourth quarter only up a couple percent on a year-over-year basis, 13-week to 13-week. It had been up for a 15%, 20% consistently for a number of quarters. Just wanted to see if you could talk through what transpired in the fourth quarter in terms of your strategy or timing?

Alex, this is Lance. I will start with that. As we noted, we ran a pretty significant comp in the fourth quarter of 7%. Really, just there was not anything in particular with any given market. We just had a general across-the-board royalty increase, I don't think there was anything real significant there.

Okay. And the international franchise, looking at the year-over-year increase in royalty revenue. Am I right with it up a couple percent, or am I looking at the wrong thing in the fourth quarter?

Well, I will tell you the other thing, Alex. The prior year had a 53rd week, or had an extra week in it. So if you are not normalizing that for an extra week of operations in 2012, that percentage is not going to look as high. I apologize I did not catch that a moment ago, but --

Okay, thanks.

-- that is, we can work through the math offline if you'd like, but that is with the 7% comp, the difference is the 53rd week.

Okay. And on the North American Company-owned business, I guess a few non-traditionals opened up in the fourth quarter. Just wonder where they are, how big they are? And is that something you're going to be focused on accelerating in the future?

Alex, this is Lance again. We don't typically give the specifics around where and how big those non-trads are. I will let Tony or Steve speak to what our thoughts around non-trads are in the future.

Yes, Steve?

Yes. I think, Alex, it is Steve. Yes, it is part of our overall strategy materially. It is not a significant impact to the overall from a comp perspective. Obviously, they are judged by non-comps, so our non-traditional venues are typically more seasonal.

Specific and higher ed and we do have some stadiums and things of that sort. It is part of the overall strategy, but not a significant part of how we will continue to grow the brand. But from a brand awareness standpoint, which is typically how we use that asset on the non-trad side of the business.

Okay. And then just a follow up on the China question earlier, and just trying to get a little more on your confidence to turn toward profitability in 2014? And what needs to happen over the course of the next couple of quarters? Anything about the status of the infrastructure build or anything else that might help us see the improvement that you see coming?

Alex, this is Lance. I will start and then hand it over to Tony. I would say a couple of things there. One thing that we should point out in China, there were in the neighborhood of $1 million of one-time type costs in the fourth quarter.

So when you look at a tough fourth quarter in China, we had some asset closures, some asset write-offs, we did have an extra month of operations in there. So there were a few things that happened that will hopefully not be recurring. Certainly there's a little bit of a bounce we are going to get from just the one-time things.

And we also opened a number of stores right at the very end of the year where you pick up a lot of pre-opening expense and those kinds of things. I will let Tony go from here.

My comment, Alex, was going to be that we have a corporate presence in that market very frequently. As a matter of fact, many of us from the executive team are about to embark on an international trip this afternoon. And that is the first place we are going.

We are hands on from the executive team all the way down in the key markets that are very important to us long term. And certainly, China is very, very important to us. We are very confident in the team and all of the investments that we are making, the strategy.

And as Lance alluded to, I think, and again, we have indicated that the profitability improvement in international, certainly, China is going to be a contributor to that. So very confident and, again, we're not to give quite detail on timing because we have a long-term approach, but in 2014, we feel good about the plan that we have in place.

Great. Thank you.

You are welcome.

Thank you. I am showing no further questions at this time. I'd now like to turn the call back over to Lance Tucker for closing marks.

Great. Thank you, Tom, and thanks, everybody, for being on the line. And we look forward to catching you up at the end of the first quarter.

Thank you.

Thank you.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program. You may all disconnect. Everyone have a good day.