Papa John's International, Inc. (PZZA) Q3 2012 Earnings Report, Transcript and Summary

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

Thank you, Rodrigo. 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 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 release and in 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 same period a year ago. This call is being taped and the replay will be available for a limited time on our website in a downloadable podcast format. Finally, given the weather events of the past few days, we appreciate everyone for being on the call this quarter. Our thoughts and prayers are with all of those impacted by the storms. Now on to our third quarter results. The third quarter was another strong quarter, as we maintained the momentum we’ve seen throughout 2012. Our third quarter diluted earnings per share were $0.55, up 25% versus the prior year. Our year-to-date 2012 EPS was $1.85, an increase of 19.4% over the prior year. Our third quarter revenues increased 6.5% primarily due to comparable sales of 2.5% for North America and 6.9% 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 6.6% increase in the number of units operating globally on a year-over-year basis. We opened 56 net worldwide units in the third quarter, continuing our strong unit openings momentum and bringing us to 146 net worldwide unit openings year-to-date. On a business segment basis, operating income for domestic company-owned restaurants increased approximately $1.3 million in the third quarter. This increase was primarily due to increased comparable sales of 2.5%, as well as favorable commodity costs, primarily cheese. Operating income for our domestic commissary business segment decreased by $400,000 in the third quarter due mainly to slightly lower prices charged to restaurants and higher fuel costs. Operating results for our international segment improved approximately $400,000 in the third quarter. These results were primarily due to an increase in royalty revenue due to an increase in the number of units operating globally and 6.9% comparable sales. Our effective tax rate was 33.8% in the third quarter. Our effective tax rate may fluctuate for various reasons, including settlement or resolution of specific federal and state issues. Please note that the prior year included significant favorable tax resolution items. We repurchased approximately $25.4 million of stock during the third quarter, bringing our year-to-date repurchases to $64.1 million. The company has approximately $51.8 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 $68.3 million for the first 9 months of 2012 and $73.5 million for the trailing 12 months. This represents a free cash flow yield of 5.8% based upon $23.7 million average diluted shares outstanding and yesterday’s $53.32 closing market price. Based on our continued strong performance, we are increasing our 2012 earnings per diluted share guidance by $0.08 from a range of $2.45 to $2.55 to an updated range of $2.53 to $2.63. These ranges include the negative $0.08 impact of a one-time marketing incentive contribution and also the positive $0.08 to $0.10 impact of the 53rd week of operations in 2012. We are also raising our 2012 North America comparable sales guidance from a range of 2% to 3% to an updated range of 3% to 4% and raising our 2012 international comparable sales guidance from a range 4% to 5.5% to an updated range of 6% to 7%. We are lowering our capital expenditures guidance from a range of $47 million to $52 million to an updated range of $43 million to $48 million. Finally, we are reaffirming our worldwide net unit openings guidance at a range of 240 to 280 with updates to the unit openings guidance by business segment. Our North American net unit openings guidance has been increased from a range 110 to 130 to an updated range of 125 to 145. Our international net unit openings guidance has been changed from a range of 130 to 150 to an updated range of 115 to 135. 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, Lance, and thanks to everyone on the call for adjusting your schedules so you could join us today. Before I talk about our third quarter performance, on behalf of the entire Papa John’s family, I wanted send our thoughts and prayers to the people impacted by the Hurricane Sandy, including the good percentage of our 15,000 team members from North Carolina to Connecticut. We’re currently working with American Red Cross to dispatch our mobile kitchen to feed local residents and aid workers in some of the hardest hit areas, as they do their best to recover from this tragedy. Moving on to the business, as Lance mentioned, we are very pleased with our third quarter performance. You may recall that despite a sluggish economy, we anticipated a good summer for Papa John’s and we were right. Our performance was better than our expectations. As always, I’d like to also congratulate our franchisees and our operators for another outstanding quarter. Their continued confidence in the brand and their laser-like focus on delivering on our better ingredients, better pizza brand promise around the world resulted in a 2.5% North America comp and a 6.9% international comp. On a 2-year basis, our North America comps were nearly 8% and our international comps were over 11%. And I like to emphasis that our performance has allowed us to operate in a true win-win environment, for our franchisees are winning with increased comp sales, our shareholders are winning with a 25% increase in EPS, our corporate team members are winning by working for a company on solid financial footing and are on pace and in place for a record bonus payout. Our suppliers naturally are benefiting from increased sales and most importantly, our customers are benefiting from the best quality pizza around. Let’s look at some of the specifics from the third quarter. Our strong comps during the quarter were bolstered by the start of the NFL season as we entered the third year of a multi-year sponsorship as the Official Pizza of the NFL as well as Official Pizza of about half of the NFL teams throughout the country such as the Washington Redskins, the Dallas Cowboys, the New York Jets and Giants, and of course, the Denver Broncos. Our partner, Peyton Manning, who by the way just became a Papa John’s franchisee, buying into 21 restaurants in the Denver market, has been a hit with consumers as together we launched our 2 million pizza giveaway throughout the NFL season. The early numbers from the start of this season have been very encouraging and have reinforced the notion that quality is a winning proposition. Partnering with one of the most powerful brands and one of the most credible, likable and marketable spokesperson is a winning combination we hope to capitalize on for a long, long time. Now on to the development front. During the quarter, we were very excited to celebrate the opening of our 4,000th restaurant in our system just out of New York City in Hyde Park. This restaurant, as Lance noted, is one of 56 restaurants we opened around the world during the quarter. That gives us 165 net restaurants year-to-date. Our global development pipeline remains very robust with about 1,500 restaurants scheduled to open globally over the next 6 years, aided in large and part by our 2012 develop an incentive plan that continues to be well received by current and potential franchisees. Everyone always wants to be part of a winning team and the interest we continue to receive from perspective franchises certainly bears that out. Turning to our international business, it also continues to perform very well with revenues increasing 17% for the quarter. I traveled to several international markets during the quarter and I am pleased to report back that our international franchisees are winning by focusing on product quality and running the restaurants the Papa John’s way. In fact, both our international and North America pizza scores and service levels hit an all-time high during the quarter, and nothing is more important to me in the health of the system than succeeding in our day-to-day fundamentals, breathing [ph] at the basics every day. And our brand continues to be very attractive to potential franchisees around the world too. In fact, during the quarter, we opened the first Papa John’s restaurant in Azerbaijan bringing superior quality pizza to more than 2 million residents in Baku. Before I turn it over to Lance, I want to mention that I feel it’s very instrumental to have and build a world class Board of Directors and that’s what we continue to do here at Papa John’s. To that end, I’d like to welcome to our board our newest Director based in London, Chris Coleman, who will be vital in helping us continue to build long-term shareholder wealth. And with that, I’ll turn it back over to Lance for questions.

Thanks John. Rodrigo, I think we are ready for questions.

Our first question comes from Chris O’Cull with KeyBanc.

Lance, if you normalize the fourth quarter for the $0.08 to $0.10 benefit from the extra operating week, and your guidance looks like it implies really flat earnings year-over-year, I guess, I appreciate cheese is higher in the fourth, but why wouldn’t earnings grow with 3 -- looks like 3-plus percent comps and 6% unit growth?

Chris, I’ll start with that one. I think what we’re doing, we’ve got guidance out here that we feel is realistic and attainable and what we think we’re going to actually run. We are going to see a fairly difficult commodity environment in the fourth quarter. You can look at the cheese features and see that, as well as continued difficult competitive environment. So we feel like we’ve given guidance that is appropriate, but the fourth quarter is going to be a difficult quarter from a commodity side. And we’re happy with where we in our momentum, but we want to make sure that we’re -- we stay competing the way we are.

Just looking at some of the costs, do you expect the advertising to be up meaningfully year-over-year in the fourth?

Chris, this is Andrew. I’ll go ahead and take that. We would expect that to be up slightly and very consistent with what we told you on past calls relative to the number of TV weeks as an example that we’ll have which have increased year-over-year.

One other comment, Chris, if I may, as you look at these JVs that we’re bringing into the fold here in Minneapolis and Denver, they are driving some of those number a little bit, because we do a fairly significant amount of marketing spend to get those markets where we want them.

Okay. And then lastly, if you just look at G&A cost, I mean they’ve been rising at a faster pace than revenue. Should that continue? Or when would we start to see some leverage on the G&A line?

I think there’s a couple of things going on there, Chris. One is due frankly to all the momentum we have in the very good quarter, you’re seeing good management incentive, bonuses and payouts included in that number, so certainly we don’t budget those quite as high as what we’re seeing. And then in addition to that, we’re trying to be cognizant of balancing our growth with having a proper infrastructure. And so you’ll continue to see us add infrastructure where we need to. I do think, though, with all that said, that on the incentive side, because of the year we’re having, it is driving that G&A up a little higher than you would typically see.

And Chris, this is Tony. Again, we typically, I know -- we don’t manage it quarter-to-quarter. It's not any given quarter that significantly changes our long-term approach. And to Lance’s point, margin pressure in Q4, I mean, cheese cost is certainly going to create some margin pressure for us. Our investment within the quarter, both on some of the markets that we’ve acquired, plus some of our infrastructure for long-term, but very -- I think we’re well on track for our full year guidance. And obviously we’re not talking 2013 on this call, but we’ll give you further guidance on that. But our long-term strategy is consistent, steady growth and we’re right on track with that.

Next question comes from Peter Saleh with Telsey Advisory Group.

Just wanted to ask on the -- first on the international unit growth, it looks like you took the numbers down slightly for the year. Can you just elaborate a little bit more on why that is? Is there something there with timing?

Peter, this is Tony. Yes, it is absolutely timing. As you know, we’re typically back-end loaded in our development in our growth numbers every year. So we’ve got a few logistical opening issues of stores that we’re planning on opening right toward the end of the quarter that actually are still going to open, just not quite up on this line of the end of the quarter and will at the beginning of Q1 -- right at the beginning of Q1. So some equipment and construction logistics challenges on a few restaurants.

So we should see -- should we expect, I guess, first quarter of '13 to be a little bit heavier than usual on the unit growth side since some are going to shift?

I think, again, I don’t want to talk to -- get ahead to 2013, but we’ll be on our -- from a path standpoint, we will be on track with consistency from last year to this year into'13. So you’ll see those openings happen in the beginning of the quarter.

Okay. And then just wanted to ask on the comps, it looks like the company comps, again, were pretty robust, more robust than the franchisee comps. Can you talk about the difference there between the 2, and what you think is driving the gap?

Pete, it’s Steve Ritchie. I’ll take a start on that one and first I’ll say very pleased, obviously, with both our corporate and our franchise performance. And again, we’re always looking at the business at a 2- and a 3-year basis; 2-year comps on the corporate side of the business over 11.3. The franchise side of the business is also a very respectable 6.6. We’ve talked about this on past calls over the last 8 quarters, really. You're seeing 7 out of the last 8 quarters the corporate side of the business is outpacing. We are leveraging the strength really on the corporate side of the business, but you're continuing to see some variability due to market penetration, different levels of locals for our marketing, in addition to the acquisition of Denver market and Minneapolis playing a little bit of a role in some incremental growth, we are pleased with the initial results there. But it continues to be an area of focus of opportunity on focusing on our below-average performers, as we have those on both the corporate and the franchise side of the business, but as a whole, our business continues to grow and pleased with our corporate operators' leadership perspective really driving our organization.

Peter, this is John Schnatter. The thing to know here is, the franchises are also seeing what you are seeing is that the corporate performance exceeds the franchisees’ performance, not only in comp sales, but just about in every single matrices. And so what we are seeing is they’ve kind of found religion. They are kind of coming to us and going, hey, what are you guys doing? To Steve’s point, we didn’t get here by what we did this quarter. We’ve gotten here at what we’ve been doing in the last 3, 4, 5 years. So they are starting to come online and do things the way the corporate's doing, and we think we’re going to see a lot of good things in the short-term, and the near-short term with our franchisees.

Great. And then, Lance, just a quick question on cheese. Are franchisees, I know you guys were locking up or hedging some of your cheese, obviously, for a short while and it seems like you’ve probably had some success with that given the run up in cheese. Are franchisees coming back to you and saying, hey, we are interested in doing what you guys are doing now?

Peter, what I can say there is, we do continue to discuss it with the franchisees and share our results with them. We’re kind of still putting our toe in the water on this, as you know. And so we are going to let a little time pass, excuse me, and -- but we do continue to have that dialog.

Peter, this is again John Schnatter. It’s interesting, your question kind of begs the differences in mindset. There was a period a little earlier in the year where we actually were paying a little bit more for cheese, and frankly that did not bother us. Our business is one, if we get the first part of the year off to a good start and we’ve got our cheese and fuel doesn’t do anything crazy, then we can be pretty solid with our year. And so corporate’s mindset is one of those, let’s cover the downside in case cheese does go to $2.20 or $2.30 and the upside will take care of itself, where I can kind of tell you that franchisees have a little bit more tendency to want to roll the dice and hope that cheese goes low. This is just different mentality. Either way we’re fine with it. The thing we do have to do is that, if we do lock the system in, we -- the other guys have to go one way or the other; they got lock in with us 100% or they got to be out in -- on market pricing 100%. And so we’re going to show them what we’ve done. We’re going to kind of share with them our knowledge and experience and what we think is going to happen. And then the FAC will make the decision whether they want to hedge cheese or not and we’ll abide by that.

Next question comes from Michael Halen with Sidoti.

My first question is about mobile ordering. So can you talk about what percentage of sales came from mobile in the third quarter? And how much do you think your strong same-store sales results can be attributed to increased mobile orders, both domestically and internationally?

Michael, this is Andrew, I’ll go ahead and take that. We’re not going to give out that specific data on mobile for competitive reasons. But I can just tell you from a online perspective, we continued to see really solid growth. As we've told you in the past, we’re well in excess of 35% of sales, and digital marketing, which includes how we approach mobile, how we approach online sales are critical components to our overall business model. And we see great growth in all of those segments.

Mike, this is John Schnatter. I don’t think you could pinpoint one attribute to marketing or even the success of the company, one piece. I think the word we use is comprehensive, and I think the reason we’re having the success we’re having in our marketing division is they have a truly comprehensive world class approach to things.

Definitely. All right. Great. And my second question is if there’s any change in your plans for cash use now with the addition of Chris Coleman to the board?

No, Mike, we -- we’re, again, staying pretty consistent with what we’re doing and no changes there that I foresee certainly. So we’ll keep you guys updated if we change our stance on that.

Yes. Mike, this is John Schnatter. Actually Chris has probably similar philosophical thoughts on capital and debt that we do, and that’s why he is part of the team. With that being said, he does think out of the box, he has an element of flexibility to him that he is open to doing things differently. But I think he is got a good intuitive grasp on markets and on banking. And I think that his counsel so far has been very insightful.

Next question comes from Mark Smith with Feltl and Company.

Can you talk first about the comp trends at all during the quarter, and anything that’s significant we should be looking at?

I’ll start, Mark. So we don’t typically talk about the ebbs and flows of a given quarter. What I would tell you and then I’ll let Andrew, Tony, and others jump in, is we had another solid quarter. And you can see from our guidance that we expect to have a good wrap to the year here, but I’ll let the other guys jump in.

This is Andrew, Mark. I would just go ahead and say that our momentum really has been consistent period-to-period and that really goes back well into 2011 and really we have just consistently done a lot of the same things. John talked about the comprehensive approach. All of that approach is built around the quality positioning, better ingredients, better pizza, premium pricing. And so we’ve been fortunate that it’s really been a consistent, continuous, nice solid pattern, which is what we like here at Papa John’s.

I guess, if I look any deeper on that, does the sports calendar make a big impact on sales? I don’t know if you can talk about it for competitive reasons, but as we look at extra Thursday night football games or Olympics, anything that really moves the needle on the calendar?

Well, I mean, obviously sports help in general, but then you got to roll over those sports periods the next year. Your comment on Thursday night football, it might help you Thursday but then you got those teams not playing on Sunday. So there’s always ebbs and flows in that. Our opinion is that you have to put yourself in the right spots to succeed in the sports segment, and we feel like we’ve done that, both on a national level and a local level. And the thing we like to see is that it continues to grow each time those seasonal opportunities come up.

And this is Tony. Just to reiterate, really it’s not any single one thing. And the other thing I would like to mention is, John mentioned it earlier, is our quality and service in our restaurants is really -- that’s the key for us from a brand position. And we’ve got all-time high consistent pizza scores from a quality standpoint and service, and you link that to our very effective comprehensive marketing approach from local store all the way up to national, it’s working and we’re continue to work our plan, very confident in our strategy.

Mark, to kind of piggyback on that, this is John. If we -- we wake up and look at this business every day, we get numbers at 6:00 at a glance and then we get the whole year and the thing solidified about 8:30. So we’re looking at this every day. And again, we are building the business for the long time, but it’s a day-to-day business. So some days you wake up and sales are not as good as you’d like; and some days you wake up and sales are a little bit better. And the days you wake up a little bit better, you kind of what did we do right and how do we do more of that? And then when sales are not quite as good as we’d like, we go, okay, what can we do from a product quality service? We always go back to our fundamentals, a; b is what can we do from a local store marketing perspective, what can we do -- go out and hustle a little bit to build things. And then we may take a look at our digital marketing to make sure that it’s on track. So it’s a day-to-day business.

Next question, kind of a 2-part thing. First, can you talk about your commodity outlook, excluding cheese, kind of what the rest of the basket your outlook is for maybe the next 12 months? And then second, as we continue to see food inflation, what’s your ability to take price? I mean do you feel like you’re positioning in really quality and service that you just talked about gives you a leg up to be able to pass through some price inflations?

Mark, I’ll hit it at 40,000 feet and then Andrew, you can kind of get down into the details. We are probably in the best position with our quality advantage to take price. I mean, the nice thing about our situation is we do make a better pizza and people notice that and they like us better and that’s just on everything you track. And so we own that position and that puts us on the high ground. The other fortunate thing is we don't operate in the vacuum. So whether it’s McDonald's, or Texas Roadhouse, or our 2 leading competitors, if we are feeling the pressure and have to take price, then they’re going to have to feel the pressure to take price. And I think all ships will have to rise in that environment. Andrew?

Yes. And I would go ahead and add to that, Mark, that relative to our approach to pricing is first and foremost, regardless of any commodity environment, we look at ourselves as the premium and quality leader, and we have substantiated that in our opinion significantly over the last 2 years by taking price regardless of what the commodity environment was throwing at us. But we also look at it from a consumer perspective, and we have to push as far as we can to make sure that we’re getting as much value for ourselves and the consumer at whatever price point we have. So we constantly look at it relative to those lenses. And obviously we’ll make, hopefully, smart decisions as we look at the economic swings and other consumer factors that enter into our business model.

Mark, this is Lance. One last thing to circle back to the first part of your question. We’re going to be giving our 2013 guidance in February this year or next year rather. So we’ll hit the commodity guidance in some detail at that point.

And the other last thing we’ll comment on commodities because I know that’s always a hot topic. We’ve seen high commodity environments in the past. We know we’ll see them again in the future and we can manage through those. We’re not -- we’re not real concerned about that. We know we can navigate through them and our -- from our strategy standpoint, we’re on track to be able to do that.

One last question from me, just as we look at kind of the delta between sales volumes at comp restaurants versus those not yet in the comp base and that trend hasn’t been favorable. Can you comment on that? Are you seeing, as you get bigger, you have now opened your 4,000th restaurant, as you fill in and open new markets, are those not opening at levels that you would like? Or any comments you can give us volumes in new restaurants.

Yes, I’ll jump in on that, Mark. It’s Steve Ritchie. We tend to be pleased with the -- the new restaurant openings have been fairly consistent over the last several years and performance of our PSAs in those restaurants complemented, and this is exactly why we align our incentive programs from a development perspective and the other incentives to help support what is certainly a much more challenging economic environment related to price and commodities. So that first year for any given business is going to be one of the most challenging years. But certainly scale to our entire North American business, as we get more market penetration into the markets where we continue to grow helps support those new franchisees. So overall I think pleased with the performance.

[Operator Instructions] At this point, we have one more questioner in the queue, Mr. Ben Fader-Rattner with Canyon Capital.

I just had one question. A lot of companies are in the process of evaluating special dividends or pursing special dividends, given the potential for a tax increase in 2013. Just curious if your thoughts have evolved with the change in tax rate for 2013?

Ben, it’s Lance. Thanks for your question. Like we do every quarter, we talk with our board on a very regular basis around our capital structure items. We’re certainly of course cognizant in -- of the impending tax changes, and so we’re considering those, but at this point that’s all the comments we’re going to have on that.

At this time, I’m showing no further questions.

Okay, Rodrigo. Well, thank you very much. We’ll end the call and, thank you to everybody for taking time to be on the call with us today.

Thank you.

Thank you.

Thank you.

Ladies and gentlemen, thank you for your participation in today’s conference. You may now disconnect.