Papa John's International, Inc. (PZZA) Q2 2012 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Papa John’s Second Quarter 2012 Conference Call and Webcast. [Operator Instructions] I would now like to introduce your host for today's conference, Mr. Lance Tucker, Senior Vice President, Chief Financial Officer and Treasurer. Sir, you may begin.

Thank you, Kate. Good morning. With me on the call today are our Founder, Chairman and CEO John Schnatter; Chief Operating Officer and President PJ Food Service; Tony Thompson, Chief Marketing Officer, Andrew Varga and other members of our senior management team. After a brief financial update, John will have comments about our business and the management team will then 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 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 even 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. Also as last noted, all comparisons are virtually the same period a year ago. This call is being taped and a replay will be available for a limited time on our website and in a downloadable podcast format. We are very pleased to have maintained our momentum in the second quarter of 2012 with diluted earnings per share of $0.61, up 29.8% versus the prior year. For the first half of 2012, our EPS was $1.30, an increase of 17.1% over the prior year. Excluding the negative impact of the marketing incentive contribution fully expensed in the first quarter, our first half of 2012 EPS was $1.39 or an increase of 25.2% over the prior year. Our second quarter revenues increased 8.5% primarily due to comparable sales as 5.7% for North America and 6.1% for international. In addition, the increased revenues were driven by the net acquisition of 50 restaurants in Denver and Minneapolis in the second quarter, higher volumes at PJ Food Service and a 6.4% increase in the number of units operating globally on a year-over-year basis. We opened 40 net worldwide units in the second quarter continuing our strong unit openings momentum and bringing it to 90 net worldwide unit openings year-to-date. On a business segment basis, operating income for domestic company owned restaurants increased approximately $1.9 million in the second quarter. This increase was primarily due to increased comparable sales of 7.4% as well as favorable commodity costs, primarily cheese. Operating income for our domestic commissary business segment increased $3.7 million for the second quarter due mainly to the higher restaurant sales volumes and higher numbers of units previously mentioned. Operating results for our international segment improved approximately $600,000 in the second quarter. These results were primarily due to an increase in royalty revenue from the increase in units noted previously and 6.1% comparable sales. Our effective tax rate was 34.2% of second quarter; our effective rate may fluctuate for various reasons including settlement or resolution of specific federal and state issues. We repurchased approximately $24.9 million of stock during second quarter bringing our year-to-date repurchases to $38.7 million following a $50 million increase in the share repurchase authorization by the company's board of directors on July 26. The company has approximately 69.2 million of remaining share repurchase authorization. Our free cash flow, a non-GAAP measure we define as cash flow from operations less capital expenditures booked $50.1 million for the first 6 months of 2012 and $81.3 million for the trailing 12 months. This represents a free cash flow yield of 6.6% based upon 24.1 million average diluted shares outstanding in yesterday's $51.01 closing market price of the stock. Based on our continued strong performance, we are increasing our 2012 earnings per diluted share guidance by $0.05 from a range of 2.40 to 2.50 to an updated range of 2.45 to 2.55. These ranges include the negative $0.08 impact of the one-time marketing incentive contribution and also the positive $0.08 to $0.10 impact of a 53rd week of operations in 2012. We were also raising our 2012 North America comparable sales guidance from a range of 1.5% to 2.5% to an updated range of 2% to 3% and raising our 2012 international comparable sales guidance from a range of 2.5 to 4.5% to an updated range of 4 to 5.5%. All other guidance is reaffirmed at previously announced levels. And now, I'd like to turn the call over to our Founder, Chairman and CEO, John Schnatter. John?

Thanks. As Lance noted, we are very pleased with our second quarter results and the positive momentum we are seeing on a number of fronts including comp sales, product quality and unit growth both domestically and around the world. I'd like to first congratulate our franchisees and operators for an outstanding quarter. In the face of a continued challenging global economy and tough competitive pressures, posted a 5.7% north America comp sales and a 6.1% international comp sales is outstanding. These results are testament to our passion for doing it Papa John's way and consistently delivering on our better ingredients, better pizza brand promise to each and every customer with each and every pizza with each and every day. It's also validation that our long term strategy of steady, consistent, sustainable growth, continues to work as you can see our second quarter results delivered very nicely against this long term strategy. In fact, that strategy has helped us achieve positive or flat comps every year since 2003. We're also very pleased that during the quarter for the 11th time in 13 years, Papa John's earned the highest rating among all limited service restaurants in the prestigious American Customer Satisfaction Index or the ACSI in the highest rating ever by an individual brand. In addition to the top overall ACSI rating for limited service restaurants, our score of 83 tied the highest rating in the full service restaurant category. We also earned the highest score regarding product quality, service quality and customer loyalty in the individual ACSI ratings for the pizza business. The ACSI win comes on the heels of Papa John's being named brand of the year in the pizza chain category of the 2012 Harris Poll EquiTrend study which measures customer loyalty which has never happened for a number 3 brand in the category to overshadow the previous number one brand. As many of you know, our company was founded and built on quality and we've always believed in serving a superior quality pizza and delivering on our better ingredients, better pizza brand promise. It's one of the things that differentiates Papa John's from our competition. This recognition is testament of pride of our franchisees, suppliers, operators and team member system wide that go about their business in a very programmatic way every day. Now here is how the second quarter came together. I want to first talk briefly about our unit development efforts to the first half of the year. Our 2012 development incentive plan continues to be well received by current and potential franchisees and as a result, as Lance noted, we've opened 40 net restaurants in the second quarter and 90 year-to-date which just puts us on the doorstep of store 4,000 worldwide and are on plan for our 240 to 280 store guidance. Looking ahead, with about 1,500 restaurants in the development pipeline, the majority of which are scheduled to open over the next 6 years, we are very excited about the future growth of the brand throughout the world. Turning to our international business, it also continues to gain momentum with revenues increasing 21.8% for the quarter. I attribute much of our international success for the quarter in the year to a continued focus of our corporate leadership and franchisees on doing it the Papa John's way. I visited several international markets recently with members of our executive leadership team including UAE, Turkey, Russia and United Kingdom and overall product quality was the best I have seen internationally. Quality is a worldwide winning combination. Before I turn the call back to Lance, I want to reiterate that we are very pleased with the momentum in the number of critical areas and we're optimistic the continued execution of our long-term strategies will create value for our current and future franchisees and for our shareholders. And with that, I'll turn it back over to Lance for questions. Lance?

Thanks, John. Kate, I believe we are ready to open the line up for questions.

[Operator Instructions] Our first question comes from the line of Peter Saleh with Telsey Advisory Group.

So I guess when I look at your guidance, looks like the past 12 months or so you've had earnings growth of about 30% and any other guidance for the rest of the year, the implied guidance really implies no real earnings growth or at least no real organic earnings growth in the backend of the year despite you've got same store sales momentum, you have some margin opportunity and international continues to grow. So was just hoping to talk about that for a minute and kind of justify why you guys think there is not going to be really much organic growth in the back end of the year.

Peter, this is Lance. First of all, we believe our guidance is very realistic and that’s what we intend to put out there. As you know, the second half of the year we're looking at probably some commodity headwinds, I'm sure you've seen that in other releases that people have put out. In addition, cheese remains volatile and we know the pizza category is going to remain very, very competitive. So we feel like our guidance is reasonable and attainable and we feel really good about it. John or Tony, would you like to add anything there?

So in terms of same store sales for the second quarter, can you talk about a little bit about the drivers of what really drove a nice acceleration in the comp from the first quarter to second?

This is Andrew. I’ll go ahead and take that. The bottom line is that we continue to do a number of things well simultaneously, and frankly, all of these activities center around our core fundamental belief that we make a better pizza. It really shows up in our key marketing communications, how we leverage our foundry as a key differentiator and also in our pricing management to ensure we remain premium to the competitive set. So, it's not just one thing we do, it’s a number of things simultaneously and frankly, they've all been coming together for a number of periods.

Peter, this is John Schnatter. Again to my comments, we've been positive for going on 8 years and the success we're having in Q2 of 2012 are the result of all of the good things we did the last 2 to 3 years. So it's not just one quarter, its accumulation of all the things that we do on a comprehensive basis every day on every week and every year.

Great. And Lance, just going back to the labor line, it delevered a little bit more than what we would have thought given the growth that you have in the digital or online sales. So, does that have to do with the acquisition and should we expect that to go back normalized as we go to the next couple of quarters?

Peter, there's couple of things there. Primarily though, with the comp sales levels that we ran, our incentive plans we paid very good bonuses at the store level and that does in fact run through that labor line and when you're running 7.4% comps on a corporate basis, you're going to see labor can run a little bit high because of that incentive program.

Also to point Peter, one of the analysts put out that the margins decreased because of G&A in some of the bonuses. That's a healthy thing when the executives and management all the way down to store level make healthy bonuses. First of all, the split is in favor of the shareholders. So if managers are making a healthy bonus which will cause that margin to decrease, it means the shareholders disproportionally are getting a higher amount of the profits.

Great and then just a last question and then I'll hop off. When you look out to 2014, I know it's still early. Anything new on the healthcare side in terms of how you guys are planning for it or what the expected impact could be in the 2014?

Again a great observation. I'll give you our point of view. Our best estimate is that the Obamacare will cost about $0.11 to $0.14 per pizza or $0.15 or $0.20 per order from a corporate basis. To put that in perspective, our average delivery charge is about $0.75 to $2.50 or about tenfold our estimated cost of Obama care to Papa John's. We're not supportive of Obamacare like most businesses in our industry. But business model and unit economics about as ideal as you can get for a food company to absorb Obamacare. Ergo we have a high ticket average with extremely high frequency of order counts of millions of pizzas per year and giving you an example Peter, let's say fuel goes up which it does from time to time and we have to raise delivery charges. We don't like raising delivery charges but the price of fuel is out of our control as is Obamacare. So if Obamacare is in fact not repealed, we will find tactics to shallow out any Obamacare costs and of course strategies to pass that cost on to consumer in order to protect our shareholder's best interest.

Our next question comes from the line of Chris O'Cull from KeyBanc.

I agree with you, John, I like it when employees get paid big bonuses. I guess my question, first one is, Lance on the last call you mentioned that the company was hedged on cheese this year. Has that been extended at all in to 2013?

Good question, Chris. Without going into a lot of detail I can tell you we have looked forward into 2013 to a degree. Prefer not to give you more details on that right now though.

Okay, let me ask, what are the obstacles to hedging and would the franchisees, would they consider participating this coming year?

This is something that we discussed with them fairly regularly. So I think it's something we'll continue to discuss with them but I prefer not to take a strong position on what they are going to do. Tony would you like to add anything there?

Yes, being that we've just entered into this arrangement that we're really kind of utilizing corporate as a test because obviously hedging we're just putting our foot in the water on that. So they are monitoring our results.

We have just started our kind of put our toe in the water and test hedging. Frankly, the executive team here at Papa John's likes the concept of hedging because while the sales in the business could be somewhat volatile, the profitability is quite stable. The food service is very consistent, the franchise is already like annuity and Steve Ritchie and Rick Thompson, our corporate operators are just very good at running corporate restaurants so if things do get tough. We are able to batten down, batten the hatches down and be successful and things are good like they are now, of course it all flows to the bottom line. So when we start off the year with a really good first quarter, then we know if we cover the downside, the upside will take care of itself and so even last quarter when we probably hedged a little on the high side and maybe lost a few cents, that didn't bother us. And now we're in a position where our hedge has helped us and we're going to try to educate the franchisees on why we think it’s a good idea. We will not force the franchisees to hedge but we think it's just prudent and good business to make sure that you cover your downside in case cheese does spike up drastically in the short period of time.

And also in addition to that, protecting the downside, just the predictability nature of that also is extreme value to us.

Another matter, Andrew, one question I had was regarding the number of weeks Papa John's has been on national advertising, or been national advertising. How has that trended over the past few years? Things like as more stores, domestic have stores opened, I know they contribute to the national ad fund. Have you seen that trend improve over the years?

Really what I can tell you is that we are having record number of weeks in TV, we told you that in the past and that's pretty much what we'll stick to in terms of commenting.

Fair enough and then last question, Lance. There were more international stores closed than we expected and I guess compared to the recent trend this quarter, any color on those closings?

Really not, you're going to have ebbs and flows just a little bit but we remain committed to our 240 to 280 guidance and both on the domestic and the international side. So nothing out of the ordinary.

This is Tony. I certainly wouldn’t take that as an indicator. We're pretty confident on our long-term path and obviously the projections for the rest of the year, we're confident in that.

Chris, this is John Schnatter. We just got back from traveling half way around the world. Myself and/or the team will go back out here in the 30 days. We are focused on international, we are dedicated to international and we have not seen the situation internationally where we do it the Papa John's way. We get a little scale where we are not successful. So we think we can replicate the success internationally and globally that we've had in the states. As you can see, the states continue to get stronger every quarter and every year but the globe is a big place and we've got a big job ahead of us. That's the bad news. The good news is that means, there is a lot of growth in front of us which we -- at store 4,000, it's nice to know that there is a possibility of 10,000 stores out there someday.

Our next question comes from the line Michael Wolleben with Sidoti.

I just have a couple of quick modeling questions. First of all, what kind of tax rate can we expect in 2012 and 2013?

For 2012 you should expect to see rates similar what we've seen in the first half which is just below 34%. For 2013 I think for right now I’d just look for 2012 and use that as your base line.

Also it seems like there was less incentive to those franchisees. If that's a sign, obviously that business was strong in the quarter. Can you give us some color on what you expect in terms of incentives in the back half of the year?

Michael, can you clarify our question? Are you talking about incentives on store openings or incentives on royalty rebates?

Incentives on royalty rebates.

Lance, you want to take that?

Yes, I’ll take that one. Actually, Michael, the incentives were actually pretty close to what we have seen and in fact with the high comps and high sale levels that we continue to see, we don't expect to see that number go down and frankly we think it's good for the business to continue to incent them [ph] to drive behaviors that we're looking for. So I would expect those to continue and as long as we think it's healthy for our business to continue operating incentives that's what we're going to continue to do.

And this is Tony. We're going to continue to be very strategic and deliberate about where we use incentives and how we use them. And obviously our model as I am sure you see from our corporate results relative to our franchise results is, we lead by example within our corporate operations. And so you'd still don't expect to see us incenting based on the key things that we're going to emphasize based on our corporate operations.

Our next question comes from Charles Temel with UBS Financial.

My question is a little more long term perspective. John you and I go back a long way and I was thinking about your future going forward. You just increased the responsibilities to your immediate team. So I was thinking that back in 1999 you stepped back, the stock was in the mid-20s only to return to the company in 2001 and fix it and the stock was in the low teens. In '06 when you stepped back again, the stock was at its high, I think in the low 30s and you came back in 2008 with the economic mess and market turmoil, the stock was in the mid to low teens. So my question is now with the changes you've made and the stock in the 50s, what are you thinking?

Sorry, what I am thinking as far as my involvement?

Your involvement, your future, your team.

Well you indicated that was myself that had the impact and I appreciate that, but that's a little bit not genuine. This is a team effort. We are having a success we're having because we got a very good group, very good team in the leadership position at Papa John's. To your point when you don't have the right group, things are not particularly pretty and when you have the right group, it's very lucrative and it’s a lot of fun. So the benchmark for a great company is having great bench. And my number one job as CEO and the board of director is to make sure that we have a strong and deep succession plan in this business and one of the things that was not good in '08 when I did come back, because I felt like the succession plan and people development was not near what it should be. I can tell you, Charlie, that right now we are probably as talented and as deep as I have ever seen and that gives me great comfort and the execution and the confidence in running the business. A, and B as this thing gets bigger and bigger you've got to have more and more people in the ranks that can step up to the plate to take on those responsibilities. So again, I don't want to ever step back too far from the business because if the business does get off track, it does take couple of years to get it rectified. But that being said, I am not going anywhere. I love what I do but I've got to give this next level the responsibility and direction they need to be able to run this just as well as I can run it. I just read Steve Jobs book and really admire the job he did. But I know he told them what to do and I know he told them when to do it, but since he's passed, God rest his soul, I am not sure they knew how to do it. And so the only way to let people get better is to let them actually run the business. So I'll take a little bit step backwards but it gives me great delight to give promotions and to build from within and to see people advance. And I think that is the primary responsibility as a CEO.

So this is really about developing a deep bench?

Yes great companies have a great bench and that's what we're doing here.

Charles, can I add something to that as well. I think you've seen a strong consistency within executive leadership team and from my perspective, I would tell you you've got absolutely committed executive leadership team, both committed to each other, committed to our strategy and that being said, the focus and discipline within this team permeates throughout the company to deliver on our brand promise.

And our next question is a follow-up from the line of Peter Saleh with Telsey Advisory Group.

I just wanted to ask on the, we've heard from a number of companies, economic weakness pretty broad based, nothing particularly in terms of geographies, but most companies have seen some sort of weakness in their same store sales throughout the quarter. It's not evident obviously in your same store sales numbers but just wondering if you've seen anything either in certain pockets of weakness or maybe on the flip side, if you haven't, do you think you're potentially benefiting from maybe a trade down, the so-called trade down with a lower average check when you're feeding an entire family?

Peter this is Anthony, let me go ahead and try to tackle that one. We've really seen, I would just say broadly in QSR over the past number of periods, I would say 4 to 5 periods, some pretty good strength actually across all categories. So in one sense the reports that we're seeing give us some encourage at least in our specific and broader category of QSR that from a same store sales perspective that things look pretty good. Having said that, and more specifically to us, we feel very good that we're in a unique position where we're taking some share from the larger QSR change but then also being in position to take share from the largest piece of the pizza category which is the independent. So, we're not doing anything different than we’ve told you over the last few years. We just keep running our quality – position and quality story and doing it every day.

We have a follow-up question from the line of Chris O'Cull with KeyBanc.

John, I know you love this question so I thought I would ask it. Given the company's momentum and just the low leverage, financial leverage. I wouldn’t abort considering paying a special dividend to shareholders. It seems like you could pay a meaningful dividend and then repay the debt in just a few years. What's your thoughts on that?

Well, Chris, being the principal shareholder, I am not totally opposed to that, you used the magic forward momentum and momentum's a hard thing to get, but once you got it, you have to really respect it, you've got to stay humble and you've got to keep earning it every day. And so we do have momentum. I can assure you that from a capital structure, dividends, price per share, this is something the board is very diligent on every meeting. I think you would agree that we've been pretty conservative with our balance sheet. We saw 3 or 4 years ago that the economy may get pretty rough and it did. And we want to make sure we were in a position where we could protect our employee's jobs. We want to make sure that we could protect the fact that if we needed resources to go out and buy things, to make the company better, that we wouldn’t hesitate and we have. With that being said, at the end of day, the moneys are the shareholders' moneys. And we have to do everything we can to deliver them the dollars that we think are justified and to build long term shareholder wealth, which we do every day. All that being on the table, it is nice to have basically a $3 billion system wide sales neck in 2013 at the company's pay force. So we have options and I always like to have options. And so we're going to wrap those options and of course always act in the best interest of the shareholders and how we get those dollars back out to the owners. All that put on the table Chris, it's been pretty nice to go from 20 to 50, no?

I agree.

[Operator Instructions] I am showing no further questions at the queue in this time. I will turn the call back to management for closing remarks.

Great, Kate thank you very much. Thanks, everybody, for being on the call and we will talk to you 3 months from now.

Thank you.

Thank you.

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