Papa John's International Inc (PZZA) 2016 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to Papa John's third-quarter 2016 conference call.

(Operator Instructions)

As a reminder, today's conference is being recorded. I would like to introduce your host for today's conference, Mr. Lance Tucker, Chief Financial Officer. Sir, please go ahead.

Thank you, Michelle, and good morning, everyone. Joining me on the call today are our Founder, Chairman, and CEO, John Schnatter, and our President and COO, Steve Ritchie, as well as other members of our senior management team. After the financial update, John and Steve will have comments about our Business, and the management team will then be available for Q&A.

And our discussion today will contain forward-looking statements that involve risks related 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. And all statements made on this call are as of today.

Please refer to our earnings press release in the Investor Relations section 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 a replay will be available for a limited time on our website and in downloadable podcast format.

Now on to a discussion of our third-quarter operating results. Diluted EPS in the third quarter was $0.57, up 27% over 2015, due primarily to continued strong North American restaurant results. Third-quarter revenues were up 8.5%, mostly driven by 5.5% higher comp sales in our North American restaurants. In addition, [QCC] revenues increased over 6%, and international revenues were up over 7%. We opened 36 net global units in the third quarter -- 27 on the international side and 9 in North America.

On a business segment basis, operating income for domestic company-owned restaurants increased $3.5 million, due mainly to a 6.3% comp sales increase, a 5% increase in the number of units, and lower commodities than in the prior year. Operating income for the North America franchising segment was up $2.7 million, due primarily to 5.1% comps, and lower sales and development incentives. Operating income for our domestic commissary segment increased by approximately $1.1 million, primarily due to higher volumes.

Third-quarter operating results for our international segment decreased approximately $100,000. We generated strong 7.6% comps and good unit growth. However, the higher profits that resulted were offset by a non-recurring charge of $800,000 in the United Kingdom relative to lease accounting. In addition, we were negatively impacted by foreign currency exchange rates of approximately $400,000, primarily due to the weakening of the British pound.

Our unallocated corporate expenses increased versus 2015 by $2.9 million, mainly due to increases in incentive compensation from higher overall operating results, as well as higher interest expense. Our effective tax rate was 28.4%, up 70 basis points versus the prior year, as 2015 had a higher level of tax deductions and credits. We repurchased $13 million of stock during the quarter, and currently have about $95 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 $77 million for the first three quarters of 2016, down versus 2015 due primarily to unfavorable working capital changes associated with the payment of a previously disclosed legal settlement of $12 million, as well as higher capital expenditures, including investments in our new Georgia QCC that will open in 2017.

Moving on to our expectations for the full-year 2016, diluted EPS guidance is increased to a range of $2.46 to $2.52, from the previous range of $2.35 to $2.45. All other previously issued 2016 guidance is reaffirmed. Our revised EPS range would result in full-year growth of 18% to 21% over adjusted 2015 EPS, so another strong year.

We expect comp sales to remain strong in Q4, but fourth-quarter EPS [will go] at a lower pace than we've seen in the first three quarters of the year, due primarily to higher auto insurance expenses, including higher premiums, and reserves of several million dollars. This is all built into our guidance. 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. Thanks for joining us on the call today as we discuss our third-quarter 2016 results. I'm pleased with our solid third-quarter results, with strong comp sales leading to another quarter of excellent earnings growth. Our strong digital platform, commitment to quality, and consistent approach to growing the global footprint have us well positioned to maintain our momentum through the rest of the year and well into the future.

A few highlights from the quarter include the following: EPS in the third quarter was $0.57, up 27% over 2015. These results were driven primarily by strong domestic and international comp sales and unit growth.

In terms of net unit growth, in the third quarter we announced the opening of 36 net global units -- 27 openings on the international side and 9 in North America. This quarter alone, we announced expansion plans in Mexico, Egypt, and Russia. Mexico was the site of our first international restaurant 12 years ago, and we plan to open 60 more restaurants over the next eight years. Russia is also our top-performing international market, and we plan to add 40 restaurants over the next eight years as well. At September 25, 2016, there were 4,971 Papa John's restaurants operating in all 50 states, and in 44 international countries and territories, on our way to store 5,000.

In August, we announced the renewal of our partnership deal as the official pizza sponsor of the NFL and the Super Bowl. The NFL has been a great partner for many years, and Papa John's continues to be the pizza of choice among NFL fans. For the past four years, Papa John's has also been the most recognized brand among avid NFL fans, and that's a testament to the power of live sports and Papa John's strong fan engagement.

In September, we celebrated the start of football season with a new TV spot featuring Peyton Manning as our first-time fan. We also debuted a kickoff offer of two medium pizzas, two toppings, for only $6.99, and a brand new dessert, the cinnamon pull-aparts. We're happy to say the deal and the dessert have done very well for us.

Staying with the sports theme, we're also wrapping up our first season as the official pizza of Major League Baseball. Our Papa Slam promotion has performed very well, and we look forward to a long and successful partnership with MLB for many years to come.

I started the Company over 30 years ago with a commitment to providing families with the highest quality ingredients on our menu. I knew that with better ingredients, we could create a better pizza for everyone to enjoy. We continue to deliver on this promise today. In an open letter to Moms and Dads of America, we made a promise in July of 2015 to remove 14 unwanted, unnatural ingredients from our menu by the end of 2016. I'm proud of my team, and I'm proud to say we kept our promise and completed our mission to remove these 14 unnatural ingredients from our menu a few months ahead of schedule.

We continue to be the brand leader when it comes to plain, clean-label ingredients, by achieving milestones on our promise of better ingredients, better pizza. We're incredibly proud of the work we have done, and continue to do, to fulfill this promise. As part of our clean-label commitment, Papa John's was the first national pizza delivery chain to announce the removal of preservatives such as BHA and BHT; flavor enhancer, MSG; cellulose; and partially hydrogenated oils; and, of course, high fructose corn syrup.

We started 2016 by announcing we were the first national chain to remove artificial flavors and colors from its entire menu. We also fully transitioned our chicken used in the grilled chicken pizza topping and chicken poppers to be fed on a vegetarian diet, and raised without human or animal antibiotics. As we promised this summer, we completed the transition to cage-free eggs across the entire menu. As I've said in the past, you can't make good wine from bad grapes, so we continue to make significant investments in improving our quality from the bottom up.

Last, but not least, in October we had our biggest product launch in a decade with our new pan pizza. It's been about 1.5 years in the making, including rigorous consumer testing, product development, and operational investments in our system to make the new handcrafted pie. Not only does the new handcrafted pan pizza taste great, but it's also made with simple, clean-label ingredients: fresh, never frozen, pan dough, with no artificial preservatives.

The crust features several simple natural ingredients. The seasoned, hearty, fresh-packed pizza sauce is a variation of our signature fresh-packed pizza sauce that we use on our original pizza, no paste. It's covered in our signature cheese all the way to the edge of the specifically crafted, caramelized cheese crust.

Finally, it's baked to a thick, golden crust, for a delicious crispy-on-the-outside, fluffy-on-the-inside pizza experience. We've received a lot of positive feedback from the consumers, and are really happy with the performance over the past couple of weeks.

To wrap it up, I'm excited to finish out Q3 strong, and carry that solid momentum through the end of the year. With that, I'll turn it over to our President, Steve Ritchie. Steve?

All right, thank you, John, and good morning, everyone. I'd like to start by thanking our franchisees and operators around the world for delivering another strong quarter. As John stated, in the third quarter our comp sales were a strong 5.5% for North America, marking a category-leading 24th consecutive quarter of positive comp sales. Our North American business is led by a passionate group of corporate and franchise operators that strive each day to execute upon the core fundamentals of the Papa John's brand. Our strategic focus of enhancing the customer experience is driving consistent sales growth, and it has put us on pace to produce another year of record sales and profitability for our corporate and franchise restaurants.

On the international front, our Q3 sales comps were also strong at 7.6%, representing our 27th consecutive quarter of positive comp sales. We continue to produce very robust sales growth throughout Europe, Latin America, and the Middle East. Our strong unit economics in these regions, along with record new country openings for 2016, have driven our global development pipeline up to 1,350 stores. As we look towards 2017, we're confident it will be another year of strong sales, profit, and unit growth.

One of the biggest reasons for our success this quarter, and for over three decades, has been our focus on delivering a not only better pizza, but a better experience to our customers. We continue to strive to deliver on both fronts with the new product innovations, like our new pan pizza, our significant efforts in the investment around clean ingredients, and recognizing the importance of culture, because we know that our customers' experience will never exceed our team members' experience.

As John mentioned, earlier this month we launched our biggest product innovation in a decade, the new handcrafted pan pizza. We spent the past 18 months-plus developing the recipe, the cooking process, and preparing operators for making a pizza that takes longer to bake than our traditional crust version. I'd like to commend all of our franchisees and operators who believed in the quality of the product, and saw the opportunity for increased market share.

Also a big thank you to our R&D team for bringing the product to life, by producing a new fresh dough and fresh-packed sauce which meets our gold standard for better ingredients. The new handcrafted pan pizza is more of what pizza fans love and have come to expect from Papa John's.

In addition to product innovation, we're focused on digital innovation to attract new customers, and to drive growth and efficiency. This is why we became the first national restaurant chain to launch a customized app exclusively for the Apple TV platform. We were attracted to Apple because of its commitment to innovation and customer experience, two priorities that Papa John's is always seeking to evolve.

Our continued investments in technology will also be focused on foundational improvements to our digital channels to increase our order conversion rate, frequency, and ticket average. Earlier this year, we announced we were the first of the national pizza chains to reach 55% in online sales, and we're continuing to push higher and higher.

In closing, the passion and commitment to excellence from all of our team members around the world continues to excite me. We're very proud of our strong third-quarter global results, producing momentum that will carry us through the end of this year and will position us well for 2017. With that, I'll turn it over to Lance for questions.

Thank you, Steve. Michelle, we're ready for questions.

(Operator Instructions)

Mark Smith, Feltl and Company.

Thank you, and good morning, great job once again on the quarter.

Thanks, Alton.

You know, if you could just talk about -- it is still very early in the pizza pan launch, a couple of weeks here since October 10. I know you made some comments, John, that you are pleased with it. It sounds like it could be a pretty big deal. Is it too much to say that this could be the biggest new product you guys have had in quite some time?

Sure Alton, it's Steve, I'll start and maybe the others will comment. Certainly, it is the biggest product launch we've had in over a decade. The opportunity that this presents from a market share standpoint, clearly a pan pizza is a desired product from a consumer standpoint. We do think, based on the fact that all of our national competitors already have a pan pizza, it's going to provide a real opportunity to cut into that and add some additional market share to Papa John's.

With that being said, we never set out for short-term benefits from the products, so all of our marketing initiatives align for this to be a long-term play for Papa John's. But it certainly presents big opportunities for Papa John's.

This is John.

I'd just comment that we have a corporate store restaurant in the building, with our 800 employees in the building, and I always watch what they do. For example like the brownie or the cookie, I mean they ate it, and the consumer, they loved it, too. But what is amazing is the pan pizza's outselling the original in the building, so that gives me a lot of confidence that we have a quality product.

That's interesting.

I want to ask, there's been a lot of news out recently about the NFL viewership being down significantly year-over-year. Obviously, the NFL partnership is a big part of what you do. Have you seen any impact at all from that, that you can tell?

It's John, and I will let Steve comment on -- give a little more color. What we did this year that was -- I'm big on redundancy, and so the NFL has been on fire for like 10 or 15 years. I think last year, the Top 10-rated shows were NFL. And so we moved a little bit of our assets over to MLB this year, and MLB's on fire. So while we might have lost a little bit on NFL, we had the redundancy on MLB.

Another dynamic is Peyton went from playing to a fan, and so the commercials have done quite well. But it's the dichotomy and the dynamics of him having -- as a fan versus a player is something that we have to deal with.

Sure, Alton, it's Steve. I would comment and add a little additional color. So I would agree, making sure that we have a very balanced question terms of our marketing initiatives, the allocation of our investments. Clearly, the NFL ratings are down, but as you well know, still Top 10 overall viewership on a week-to-week basis within the games.

So our allocation of our investments into not only MLB the moving allocations into digital and other items that we play to drop our quality messaging. So we still feel really good about the long-term benefits of the NFL. It's certainly something that we monitor, and the NFL is monitoring it as well. And they will make good on any issues related to the ratings.

One last question and I will hop back in the queue if I may. You mentioned Lance, it will be $7 million of insurance charges in fourth quarter. I assume, A, that's the catch up perhaps. But, is there anything to read from that heading into 2017, as far as whether your insurance costs might be up or flat or what have you, year-over-year next year?

Yes, so couple of things and I want to sure I heard you right, I did say several not seven so just want to make sure that it's first of all several million dollars not seven.

I'm sorry.

No, I just wanted to clarify. As we get into 2017, we will give our guidance at the end of February as is our usual practice. What I can tell you that we will continue to be a headwind in 2017. It will not be several million dollars per quarter.

You know is more likely to be that kind of amount for the year. It will be much more pro-rata throughout the year. And again without getting into guidance, that we're not ready to give yet, I can go on until we're going to have it solid sales year, we're going to have solid EPS despite these headwinds in 2017. We will give you more detail in February.

And your next question comes from the line of Chris O'Cull with KeyBanc. Your line is open. Please go ahead.

Just a follow-up on the new pan pizza launch. It appears the introductory promotional price may be over for that. Is that correct? And then also what should we expect in terms of incrementality going forward from the pan. Is this a check driver, or a traffic driver, both? Maybe you could help us that.

Sure, Chris. It's Steve. I'll comment.

So first off the national advertise price of $10 for up to three toppings on the pan is still out there and is valid and we will continue to promote that price point throughout the rest of 2016 and then we will determine what we want to do in 2017. But never intended it to be a check builder. Intended it to be a traffic builder. Back to my comments before on market share potential. So the overall check average isn't any significantly lesser more than what we traditionally see on our overall check. But just the opportunity from a market share standpoint based on the potential overall mix of the product.

And have the knowledge of course the rest of the overall category on how pan performs. So again this is one that we're optimistic on the long-term. We never sought out to get big short-term gains of this because there was some operational change management required just in terms of the complexity with what it takes to bake this product. So we look for this to really drive long-term growth.

Yes, Chris, this is John. Our biggest competitor is doing any 12-inch pan pizza for seven bucks. And we're doing three toppings pan pizza. In other words 40% higher on price, and we're mixing higher than any product we have ever launched in history of the Company.

Just a follow-up on that, that leader has been very good at using aggressive promotional offers to gain share and they seem to be able to protect the check by encouraging consumers to put more items in their online basket. How does Papa John's prioritized gaining share like that versus expanding or maintaining store lever margin. I'm trying to get to is it more important to gain share in these early stages, where we're seeing the market consolidate?

Chris, are you referring to? Can I ask?

It seems like Dominos has had quite a bit of success with this strategy of gaining share.

Right. We totally respect our competition. Dominos' numbers speak for themselves. I think you got a look at the positioning of the brands, Little Caesars $5 pizzas is cheap. Papa John's is a premium brand. It's more expensive, Dominos obviously owns value and speed.

The other big player is in the middle. We call that Death Valley, and that's not a good place to be. Since I'm fanatical about quality, I like our position and we do get a premium for our product.

It's Steve, I will just comment a little bit more color on it. So I think what we've been able to do is really stay focused on traffic, especially over the last six years here. The majority of our growth has been through traffic. That traffic is driving enough incremental sales to drive margin growth, as well. Our ticket growth is not really come via price, it's come via product mix. So we've had some nice additions to the menu and that balanced equation and the drive in the growth on the digital side.

So you know back at the end of 2010 we were at 28% online sales mix overall in the US. And now we're over 55% online sales mix, as you well know. A higher overall ticket online, higher overall frequency, and then the addition of our Pappa Rewards program that continues to grow and be very successful contributor to traffic and margin for the business.

And then just one last one. Steve, the international net additions flowed this year and understand that was largely because you had several conversions in the prior-year. But is it fair to assume that openings will grow again in 2017?

That's certainly our focus, Chris. I think if you look at, as I stated in my opening remarks, the additional record new country openings for 2016 really puts us in a position to accelerate growth in the long term. I don't want to get too specific into 2017, but if you look at this year, this was a setup year to start driving accelerated international growth.

This has been the best in the history of the Company as far selling franchises. So the pipeline is full. Now that doesn't mean we are going to open them. But at least the pipeline is full and we have an opportunity to get lucky here.

And our next question comes from the line of Alex Slagle with Jefferies. Your line is open. Please go ahead.

I had a question on the same-store sales guidance. The reiteration of the 3% to 5% domestic outlook that suggested pretty ride range for the fourth quarter. So any commentary to keep us on the right track here? That would be helpful.

Sure Alex. It's Steve, and Lance will jump in, as well. I think as we talked about after the second quarter, the momentum that we gained in the second quarter obviously that continuation in the third quarter, expecting the same into the fourth quarter clearly the addition of the pan pizza, although again not looking for tremendous short-term gains on that product. But we do expect nice momentum to continue to get us in that 3% to 5% overall full year guidance, and momentum is the key here. So driving momentum to set us up for another successful year in 2017.

And then a question on development following up, with the international closure rate a bit higher than I was looking for, just wanted to get some commentary on the strategy there and what's going on. What we should expect as we look out to the future?

Sure. Alex. It's Steve again. First of all I will just comment.

I think as John alluded to the international business is performing extremely well. The regions that I have highlighted before, which were the vast majority of our overall international business from Latin America to Europe, into the Middle East, those businesses are doing quite well.

Just in terms of net unit growth having strong overall sales, driving good unit economics. Our challenges really continue to be the opportunities we have in Southeast Asia. That's where the closures have occurred. We feel like we have got our arms around that. But there are still opportunities for us to improve in Southeast Asia.

Those were the closures for this year and we feel we have got arms around kind of an outline for what 2017 looks like and a plan moving forward that business. As I say Southeast Asia's it's really predominantly focused on China. No secret the entire restaurant industry, especially Western brands, have struggled a little bit in China. We've had opportunities, as well. I wouldn't say that we're doing -- performing worse than some of the other national players in China. But we do think there was a way forward and a lot of that is focused on moving our Beijing business forward and putting it in the hands of a franchisee to bring in new thought leadership to help us move the China business forward.

(Operator Instructions)

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

First just looking at the difference between Company unit comps and franchise comps over the last 24 quarters (technical difficulty). 23 of those and that certain trend goes back for the last decade or so. Can you just walk us through why we see that difference? And is there an opportunity for franchisees, through pricing or something else to get more of comps closer to what you guys have been able to produce?

Well, I'll cover it at 40,000 feet, and I'll turn it over to Steve. You got to be careful with averages, because there are a lot of franchisees that actually do better than the Company. But to your point on average, the franchisees, they don't. We measure just about everything, quality, service, friendliness, repeat business, upsell and we measure all major Cs. And on average the company just does better with the fundamentals. We beat the franchisees on average on every single measurement, and I think that's why we produce higher per store averages.

Steve?

I guess the one thing I will comment, you were accurate. There has been a spread the last several years on corporate versus franchise performance. However the spread has gone from the 2% to 3% to, in 2016 it's is down to just over 1%. So they have been closing the gap, the vast majority of our franchisees performed quite well. Unfortunately the bottom 20%, or where the opportunities lie, and to John's point the bottom 20% of our corporate restaurants just don't have this kind of issues.

We been able to eliminate any of the tough markets on the corporate side of the business and we will continue to focus on that 20% leveraging our best practices on our corporate business. So I'm pleased with the upside potential, I don't think there's going to be to your question on price franchisees taking price, we're going to remain focused on traffic and growing market share. Because there's still clearly tremendous opportunities to take market share in the US

The average corporate store is doing well over $1 million a year. I had the privilege of taking some of our store managers and our DOs up in Indianapolis out to a Pacers game last night, and we had one of our really good managers in the suite with us. And he'll make $130,000 this year, one manager.

So that means we made $330,000, because managers, 20% -- 25% of the take. When you're doing over $1 million a restaurant you can really take care of your people. You can really pay them well, and that creates a lot of momentum and a lot of excitement and just a lot of passion for the brand.

Okay. And that leads to my next question, which is average weekly sales. Can you speak to average weekly sales at non-comp restaurants, whether they be new restaurants that haven't gone into comp base yet, or maybe nontraditional restaurants. Are you hitting your targets for sales volume at new restaurants?

Mark, I'll hit that one. This Lance at a high level. We certainly are with our new stores opening up at the levels we expected. Our non-comps are doing fine, as well. As you're aware, we don't put the disclosure in the 10-Q anymore. But certainly the new stores are opening as we would hope and expect.

Okay. And then last question for me.

Just can you speak to your ability to leverage G&A as we look into 2017. Is there a certain comp that you need to hit to be able to do that, or is 2016 as we see it, probably flattish or so year-over-year? Is that just a function of maybe a little more spend this year?

I will say a couple of things on that. First of all for 2016, as we been saying we're going to end the year with some leverage versus where we were in 2015. Small to moderate leverage is not going to be a huge number. But certainly we're going to get leverage this year, 2017 will address in February when we give guidance and have those discussions. But overall what I would tell you is yes we do expect to continue to leverage G&A as we continue to grow the topline and we're going to certainly expect to build the top line.

The only caveat or caution I would through you, is the two parts of our business that are going more than anything else are international and digital. And any investments make in those two areas specifically run through the G&A line. So when you're wondering sometimes why you don't see more leverage, that's the biggest part of the reason.

And our next question is a follow-up question from Alton Stump with Longbow Research. Your line is open. Please go ahead.

Just as far as you can say of environment -- cheese costs, although they have come back a little bit, are still -- have recovered, obviously, from where they were earlier in the year. Are you seeing any more rational behavior because of that from your smaller competitors in particular who are probably buying predominantly, if not entirely on the spot basis?

It's Steve. When you kicked off 2016 it was slightly more aggressive than what it is today. But the category remains pretty aggressive, as John alluded to before. There's certainly a lot of aggressive activity that took place in the third quarter. So I anticipate that will continue. Cheese prices have went up a little bit, but they are still relatively low levels compared to the previous five years.

So I think it will remain competitive. But our balanced value equation is clearly working quite well for us. Not only comparing us to the pizza category, but comparing us to the entire restaurant industry. Papa John's is performing at the top of the heap. So we feel like we have struck the right balance and we will be able to continue to do that and continue to take share in a category that is growing very modestly.

This is John. If you cover the downside, the upside it will take care of itself.

Head cheese went up from above to 1.70 to 2.70 per pound, very dangerous. And that's why we hedge. And right now our hedge on cheese is quite a bit lower than the actual spot price. That's why you hedge; you've got to cover that downside in case it does something radical.

Thank you. I'm showing no further questions at this time. I'd like to turn the conference back over to Mr. Lance Tucker for closing remarks.

All right. Thank you, Michelle and thanks to everyone for being on the call. We will announce our full-year earnings in late February.

Thank you, Michelle.

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