Papa John's International Inc (PZZA) 2014 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to Papa John's third-quarter 2014 conference call and webcast.

(Operator Instructions)

As a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference, Lance Tucker, Chief Financial Officer. Sir, you may begin.

Thank you, Nova. Good morning. Joining me on the call today from China are our Founder, Chairman, CEO and President John Schnatter, COO Steve Ritchie and CMO Bob Kraut. Other members of our senior management team are present with me here in Louisville.

We appreciate you joining us a little earlier than usual in order to accommodate the time difference between the US and China. After a brief financial update, John and Steve 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 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.

Please refer to our earnings press release in the Investor Relations segment of our website for a reconciliation and other disclosures related to our discussion of non-GAAP financial measures on this call. Unless otherwise noted, all comparisons are versus the comparable periods from a year ago.

This call is being taped and the replay will be available for a limited time on our website in an downloadable podcast format.

Now onto a discussion of our third-quarter operating results. Diluted EPS in the third quarter was $0.39 up 22% from the prior year. Our third-quarter revenues increased 13% versus the prior year.

We continue to see strong comp sales with increases of 7.4% for North America and 5.5% for international as well as a 5.6% increase in the number of units operating globally on a year-over-year basis. In addition, higher commodity prices drove increased PJ food service revenues. We opened 50 net global units in the third quarter, with 23 net international opens and 27 net North American opens.

On a business segment basis, operating income for domestic company-owned restaurants was up $2.6 million in the third quarter. Incremental profits from our 8.3% corporate comps were partially offset by the impact of continued high commodity prices.

Operating income for the North American franchising segment increased approximately $2.5 million in the third quarter, due primarily to the increase in net units and comparable sales of 7.1%. Operating income for domestic commissary segment increased by approximately $2.4 million in the third quarter, due primarily to higher margins. We expect the commissary pretax profit margin percentage to approximate the 2013 margin on a full-year basis.

Operating results for our international segment increased approximately $500,000 in the third quarter, due primarily to 5.5% comps and a higher number of units on a year-over-year basis. We are very pleased with the overall growth of our international portfolio, which has allowed us to grow at a strong pace despite the occasional growing pains that come with growing a global brand.

John and Steve will speak more to China in a few minutes. As we communicated earlier this year, our financial results in our corporate-owned in north China market are not improving at the pace we projected entering 2014. We currently project profitability for the full year to be relatively flat with 2013 once one-time items are removed. Our third-quarter results do include a $700,000 impairment charge to impair eight underperforming restaurants in that market.

Unallocated corporate expenses increased $3.7 million, due primarily to higher depreciation of $1 million, higher interest expense and non-controlling interest costs of $800,000 and higher G&A of $1.5 million, driven by insurance costs, professional fees and annual compensation increases. Our effective tax rate was 30% in the third quarter, approximately flat with the prior year.

We repurchased approximately $31 million of stock during the third quarter. The Company has approximately $140 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 $61 million for the trailing 12-month period. Our net debt position, defined as total debt less cash and cash equivalents, was approximately $208 million at the end of the third quarter.

We have now rolled out FOCUS, our new POS system, to over 50% of our domestic restaurants, and we expect the majority of the units to be installed by the end of the first quarter of 2015. From a financial statement perspectives, FOCUS costs reduced EPS by $0.02 in the third quarter versus the prior year. As a reminder, about 1/3 of FOCUS costs are one-time and the remaining 2/3 will be recurring as they are depreciation expenses.

Finally, we increased our 2014 full-year diluted EPS guidance to a range of $1.68 to $1.74 from a previous range of $1.64 to $1.72 and we increased our North America comp sales to a range of 5% to 7% from a previous range of 4% to 6%.

Now, I'd like to turn the call over to our Founder, Chairman, CEO and President, John Schnatter. John?

Thanks, Lance. Good morning to everyone. We're glad you were able to be with us on the call today as we discuss our third-quarter results. Our momentum continued in the third quarter and we're now in the home stretch of which has been an excellent 2014 for Papa John's.

Our franchisees and operators around the world continue to execute the fundamentals and deliver on our better ingredients, better pizza brand promise everyday and the results largely speak for themselves. Our 7% North American comp sales in Q3 is a clear indication that consumers continue to prefer a better quality Papa John's pizza. These strong sales levels led to excellent Q3 earnings growth despite continued commodity headwinds.

There's not one individual factor that is driving our results. We simply continue to hit on nearly all cylinders with all areas of our business doing their parts. Our pizza quality, service levels, distribution, marketing, digital capabilities, all these areas continued to get better. To continue this success, our focus is on continuing the team to get a little better everyday and in exceeding our previous best and to helping our franchisees and corporate operators as they deliver the best pizza experience in the industry.

Now, just as our quality-leadership position continues to help us gain market share, our digital-leadership position is also integral in the Papa John's growth story. We continue to set the pace in the digital arena and now derive just under 50% of our domestic system-wide digital sales from this channel.

But, reaching 50% digital mix and beyond really isn't the main story. A relentless focus on delivering the best possible pizza experience to our customers is the real point. We believe our easy-to-use digital ordering channels combined with the highest quality ingredients and demonstrably superior service are elevating Papa John's in the minds of the consumers.

Switching gears, our marketing team in our new agency Grey have developed a strategy in creative that are taking our brand to even higher levels. The early returns from this change indicate that we are accomplishing our objective of taking a strong brand and making it even better.

Next, I'd like to briefly comment on our international business, which overall, continues to perform very well. Continuing to comp and units allows us to grow our international profits at a good clip, despite taking a charge to write down the value, eight of eight of our north China restaurants.

Beijing continues to be a challenge. I'm here with Steve Ritchie, Bob Kraut and others on the international team to continue our evaluation of what we need to change to be more successful in the China market. We will keep you informed as we progress, but expect changes we are making to improve our position here in China over the long haul.

With that, I'll turn it over to Steve Ritchie for his remarks. Steve?

Thanks, John. I'll start by adding my congratulations and thanks to our franchisees and operators around the world for continuing to deliver on our brand promise. At Papa John's, we have built a culture of passion and pride for quality. This quality mantra drives our vision for excellence in everything we do.

We always strived to not only provide better ingredients, but to also develop better people, better technology, better branding and better customer experiences. This focused vision is what enables our strong results and ongoing success.

Now on to our impressive third quarter. The competitive environment during the quarter remained largely unchanged from what we've seen throughout 2014, progressive pricing and value offers across the category. Our system, once again, responded well with excellent comps driven by good execution, good LTOs and strong local and national marketing. 2014 will be our 11th consecutive year or flat or positive comps, so we've shown we can consistently deliver good results almost regardless of the environment.

While some quarters and years are better than others, we strive to avoid the highs and lows and deliver steady and sustainable growth over time. Our strategic initiatives through 2014 continue to drive successful results and are the catalyst for our increased full-year domestic sales guidance of 5% to 7%, acknowledging that we believe the steps we have taken give us a solid opportunity to roll over the strong 9% comps in Q4 of 2013.

As John noted, technology continues to be an area that is a prime factor in growing our sales and market share, demonstrated by our industry-leading online sales max. In addition to providing multiple convenient ways to order, we continue to thank our customers and build loyalty to Papa John's through our Papa Rewards loyalty program.

Our customers really like the simplicity of the program and being rewarded with free pizza. Like Papa Rewards, we will continue to make digital innovation investments in the areas that most significantly enhance the overall customer experience.

Also on the technology front, during the quarter, we continued the rollout our new point-of-sale system that began in Q1. We continue to expect the new system, which we call FOCUS, to have a positive impact on store-level operations and the customer experience. As Lance mentioned, we are now 50% complete with the rollout and on track to substantially complete it by the end of Q1 2015.

Our development remains on track as we continue consistently opening global units. During the quarter, we opened 50 net global units with roughly equal units added domestically and internationally. Our global development pipeline remains very robust and we continue to receive strong interest from prospective franchisees around the world.

Turning to our international business. We are pleased with the comp sales increase of 5.5% for the quarter. Overall, our international markets performed very well in the quarter, but we were held back a bit in China due to the OSI incident. I do want to highlight our continued strong performance in the UK, Russia, GCC and throughout the Middle East and Latin America. As in the US, quality pizza at a good value, combined with great execution resonates with consumers.

As John mentioned, however, we still have opportunities for improvement in north China. We are here in Beijing this week assessing our overall operation and will be making further enhancements to our marketing, menu and model to improve our brand positioning, sales and profitability. As we have said before, it takes time to build brand recognition and profitability in new markets, but we remain committed to north China as we believe it will become a strong market for Papa John's.

We continue to remain bullish on the long-term prospects of our international business as it devolves into the growth engine for Papa John's.

In closing, with three quarters in the books, it has been an outstanding year thus far for Papa John's. We're working hard to finish the year strong. Our commitment to delivering on our better ingredients, better pizza brand promise has never been stronger and we're excited about what the future holds as we continue to consistently grow the Papa John's brand.

With that, I'll turn it back over to Lance for questions. Lance?

Thank you, Steve. Nova, I believe we're ready for questions.

(Operator Instructions)

Our first question comes from the line of Alex Slagle of Jefferies. Your line is open.

Thank you. Question on the international profit growth, and I guess it's still being a little slower than you'd like to accelerate in a really big way and sounds like some of this in the third quarter was the OSI impact in the Beijing stores. I'd love to get a little more color on your thoughts on how we should think about this business, the opportunity to really turn the corner on ramping the profitability more significantly? How far away this inflection point might be in your view?

Alex, this is Lance. I'll start and then I'll let Steve and John jump in there from China.

On a segment basis, we were up $500,000 in international and that's after subtracting a $700,000 impairment charge. We were up $1.2 million in operating results, which is actually pretty significant growth that we're pleased with. I'll let John and Steve jump in from there, but I want to make sure you're aware that the operating growth is really about $1.2 million for the quarter, so pretty strong.

Alex, this is Steve. I think the obvious is stated in the prepared remarks, corporate China being a predominant amount of the setback in the third quarter. Most of that related to the impairments.

Some of that, as we've spoken to you before on the model, having two different models here. One, our restaurant base delivery model, the other being our delivery and carry-out model that we focused primarily on the last two and a half years from a development perspective.

We've had some rough patches with some of the delco units, but as you think about the way forward, we feel confident. The impairment that we have taken gives us a good platform to springboard off of as we go into Q4 and into 2015.

Alex, this is John. Frankly, slow profit growth is always too slow for all of us, not just international, but profit growth never goes fast enough for us.

Thank you. One question on the -- last quarter you had talked about the efforts to bring the drivers and transportation in house and just wondered to what extent the lower fuel costs maybe a tailwind for you forward, if that trend continues? Any other comments on why you made that change and how that initiative is helping your speed and accuracy?

Alex, this is John. Let me clarify the question. Are you talking about the drivers that drive our semis in the commissary? Because if that's the question, I'll answer it. Or if you're talking about the drivers in the stores, I'll let Steve Ritchie answer that question.

The part of the business that you brought in house or that you were working on in this year, the drivers and the transportation?

Again, this is John. That's something I can talk to. It's going great.

The culture of Papa John's, really, is one that attracts really quality people. We've gone from where we were like 80 drivers short to where we now are 40 drivers over.

We put an incentive in place for on-time, accurate deliveries and the drivers have embraced it. The scores on the matrices for PJ food service are up like 30%, so it's been a really good thing.

Thanks a lot.

Alex, this is Steve. I'll just add to that and echo what John has stated. You talk about the drivers that are working in house and the efficiencies we look for are the efficiencies at the restaurant level, so there is an investment that comes via food service. That payback we see coming the efficiencies in our corporate- and franchise-owned restaurants.

As I think you're aware, we have verbally committed and agreed upon overall margins that we take through the food service, so most of that will flow through. We'll still hit our year overall margin year to year.

Helpful. Thank you.

Thank you. Our next question comes from the line of Peter Saleh of Telsey Advisory. Your line is open.

Great. Thanks. A couple questions.

First, on the China, the eight stores that were impaired. The first question is were those legacy stores from the previous franchisee or are those stores that Papa John's opened once you guys took over that market?

Peter this is Lance.

Peter, this is -- go ahead, Lance, if you want to take that.

Yes, I'll take that one. All the stores were opened since 2010. We're not going to get into specific detail on the stores, but all of them were opened since 2010.

Okay. Then, should we expect more of these stores to be impaired, are any of them on the cusp of being impaired?

Go ahead, Steve.

Go ahead, Lance.

Alright, Pete, I'll start with that one and then Steve can add to it if we need to. We've impaired the restaurants that we believe are over valued.

Certainly, John, Steve, Bob and others are in market evaluating things, but we've impaired everything we felt like we needed to impair. We'll just have to see how it goes from here. I can't answer that definitively.

Alright. Just sticking on China for a minute, why do you guys feel the need to continue to own that market in China? Why not look for another qualified franchisee that may be able to run it on the ground there?

Hey, Peter, it's Steve. I'll take a stab at that first and John will actually may want to comment as well. We're in the market, actually this week. In fact, we've been in store visits all day long.

Clearly, if you look at the financial results we've had over the last several quarters, from a financial perspective, we've got some improvements that are needed in the market. I think our number one priority and our intentions are to really turn around some of the challenges that we have from a marketing and a menu and a model standpoint.

Long term, that is one of the options that are on the table. I think that as you can see, this is the only international market that we own corporately.

Long term, that is a possibility, but not until we get things in good working order. We definitely feel like we got a good overall strategy and some key initiatives from an enhancement perspective related to the things that I mentioned.

Great. Last question, Lance, I believe you mentioned that the domestic commissary profit, I believe I heard this correct, the margin would be similar to 2013? If that's the case, it implies 4Q commissary margins will be up significantly. Can you just talk about some of the drivers there and the pricing that you guys are taking with the franchisees?

I'll start with that one and I'll let John or Steve drop in. Clearly, we're not going to go into a whole lot of detail around the pricing, certainly around specific commodities.

What I can tell you is we have altered some of our pricing strategies and now are pricing more frequently, so we are pricing monthly. That's something we alluded to on the prior call that we would be taking a look at. So we're going to try to remove a good bit of the volatility that you've seen over the last several quarters.

What will look similar to 2013 is the overall pretax profit margin. It's going to look very close at the operating level too. Whether or not it's going to exactly line up, it's hard to say.

We will be on target to do what we thought we'd do this year. In food service the margins will look real close to what you've been seeing in prior years.

Great. Thank you very much.

Our next question comes from the line of Mark Smith of Feltl and Company. Your line is open.

Good morning, guys. First off, can you guys discuss -- international closures came up a little bit, can you talk about where that came from?

Hey, Mark, it's Steve. I'll jump on that first and comment some of the other folks.

As you may be aware, we have two separate franchise businesses within Russia. We have a very successful business in Moscow, which is the vast majority of our units within Russia. As I alluded to in my prepared remarks, is one of our strongest performing markets in all the international business.

On the other side of that we had 15 stores in St. Petersburg. We most recently terminated the agreement with our St. Petersburg franchisee, so that's what's predominantly showing up there on that closure piece in the international business. With that being said, we'll be looking quickly to find another franchisee to get back into St. Petersburg because it is a very viable market and strong potential, very similar feel and success metrics that we've seen in the Moscow market.

Then, did you guys confirm -- you'd given guidance in the past on net unit growth this year. Did you guys confirm that guidance?

Hey, Mark, it's Lance. We did. It's 220 to 235.

Okay. Then maybe for Lance, will some of the focus of rollout costs continue just slightly into 2015 or do you feel like you're going to get that wrapped up in fourth quarter?

As Steve mentioned in his remarks, we think we'll be substantially complete by the end of the first quarter. There will be a little bit of rollover costs in the Q1, but I think it ought to be relatively immaterial.

Frankly, we will give 2015 guidance in late February, but most of the stores will be done this year, which means most of the costs are coming this year. Just bear in mind the depreciation is not going to go away.

Mark, this is John. If you remember after the Q1 earnings, we were conservative in our forecast because until we got FOCUS where we thought it was going to be successful and rolled out to 1,500 plus stores and had two or three quarters under our belt with comps that we were going to be conservative in our estimates. We've had great first three quarters. FOCUS has been flawless, and so we're going to raise our estimates.

Then last one from me. Last year you guys did some investments in a DC. This year, FOCUS rollout. Is there anything on the horizon that we should be looking at as far as capital expenditures in big projects down the road?

Mark, it's Lance. You're right. Last year we did the New Jersey dough production facility. This year, of course, we had our FOCUS development costs, so CapEx each of the last two years has been a little bit higher than you would typically see. We will give guidance in February of 2015, but I will go on and share that there's no major initiatives from a CapEx standpoint that's going to have that number as high as it was this year, certainly.

Maybe I'll add one more on then. You may have more free cash flow next year. Is there any change in your outlook on use of cash? You guys have been big on buying back stock, any new thoughts on increasing dividend, anything else where you may use your cash?

Mark, this is Lance. I'll start and then I'll let the guys in China jump in if they think they need to. No real change expected. We believe repurchasing shares is an important piece of our model.

We're going to continue to do that, and, of course, we've implemented the dividend. We raised it a couple of quarters ago. Certainly wouldn't commit to doing that for next year, but that's something the Board will address. No real change, though, in our plans for cash.

Excellent. Thank you.

(Operator Instructions)

I'm showing no further questions in the queue at this time. I'll turn the call back to you, Mr. Tucker, for closing remarks.

Alright, Nova, thanks. Again, thanks everybody for joining us a little bit early. We will have our next conference call in February to report full-year results. Thanks. Have a great day.

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