Papa John's International, Inc. (PZZA) Q2 2013 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Papa John’s Second Quarter 2013 Conference and Webcast. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will be given at that time. (Operator Instructions). As a reminder this call maybe recorded. I would now like to introduce your host for today’s conference, Lance Tucker, Chief Financial Officer. You may begin.

Thank you, Ashley and good morning everyone. With me on the call today are our Founder, Chairman and CEO, John Schnatter; President and COO, Tony Thompson; SVP of Global Operations and Global OST, Steve Ritchie and other members of our senior management team. After a brief financial update John and Tony will have comments about our business and the management team will then be available for Q&A. Our discussion today will contain forward-looking statements that involve risks and uncertainties relating to future events. Actual events may differ materially from the projections discussed today. All forward-looking statements should be considered in conjunction with the cautionary statements in our earnings press release and the risk factors included in our SEC filings. All statements made on this call are as of today, and we undertake no obligation to update the information on this call in the event facts or circumstances subsequently change. In addition certain financial measures we use on this call are expressed on a non-GAAP basis. Our GAAP to non-GAAP results reconciliations 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 a replay will be available for a limited time on our website and in downloadable podcast format. Finally we ask any media to be in a listen-only mode, since this is primarily an investor call. Now on to a discussion of our Q2 operating results; we’re very pleased with our second quarter results with adjusted diluted earnings per share of $0.76 up 29%. Our year-to-date 2013 adjusted EPS was $1.60, an increase of 16%. Our second quarter revenues increased 9.6%, primarily due to comparable sales of 3.4% for North America and 6.8% for…

Thanks, Lance and good morning to everyone. I am glad you took the time to be with us on the call today. I’ll begin as always do by congratulating our franchisees and our operators throughout the world on another strong quarter. We built a nice momentum throughout the first half for this year, including as Lance noted, solid second quarter comp sales in both North America and international division, a strong increase in EPS and continuing momentum in net restaurant openings including the opening of our 1,000th restaurant outside North America. While the operating and competitive landscape remains challenging all around the world, our operators continue to persevere by focusing on quality and consistently delivering on our better ingredients, better pizza, brand promise each and every day. That focus on quality continues to be a winning strategy for us. It also continues to resonate with the consumers as they recognized Papa John’s as the leader in customer satisfaction during the quarter for the 12the time in the past 14 years by ranking Papa John’s the number one national pizza company in American Customer Satisfaction Index survey. This recognition is humbling and continued validation that our focus on quality is a winner. Next, I’d like to briefly comment on our international business which continues to perform very nicely. Our franchisees throughout the world have fully embraced doing things the Papa John’s way in every aspect of the business. And as a result we’re performing very well operationally around the world and are continuing to grow our brand. During the quarter as I mentioned we opened our 1,000th international restaurant. Very few brands in any industry, any industry have opened 1,000 stores internationally so we view this as a significant milestone which we will celebrate globally later in this quarter. Next I’d like to comment on the decision by our Board of Directors last week to initiate a quarterly cash dividend to the shareholders. As Lance noted a dividend of $0.25 will be paid out at September 20th. This is the first cash dividend in the history of the company which speaks to not only our consistent strong operating performance over the past year but the solid financial footing of the company. Finally as you know last week our Board also approved the promotion of Tony Thompson, President and Chief Operating Officer. Tony has been a valued leader in our organization who has earned the trust and respect of his peers, team members and our franchisees.– I congratulate Tony on his promotion and am excited that the two of us will continue to work together to drive the company forward. With that I’ll turn it over to Tony for his remarks. Tony?

Thanks, John. I would like to echo John’s congratulations to our system on another solid quarter. Each week we face increasing challenge from a variety of areas including our competitors and a still struggling global economy. But our system consistently remains focused on the fundamentals, running our operations, the Papa John’s way. As a result they have risen to meet each and every challenge and have positioned themselves and the company for continued growth. So let’s look a little deeper at the second quarter numbers. From a sales perspective our North American operators posted a 3.4% positive comp sales performance during the quarter, including a strong 6% positive comp sales increase for our company owned restaurants. Our international operators also posted a solid 6.8% positive comp sales during the quarter. A continued focus on the fundamentals and consistently delivering on our better pizza brand promise throughout the world are driving our steady and consistent sales performance. Our global product and service scores remained at an all-time high time through the quarter which has enabled us to meet the high expectations of our customers. During the quarter we realigned our international division under the leadership of Steve Ritchie, who is our SVP of Global Operations and Global Operational Support and Training which has given us even better alignment between our North American and international operations. So I continue to remain very bullish on the future of Papa John’s international operations and the runway we have for continued growth as we continue to plant the flag of better ingredients, better pizza around the world. Much like our sales we are very pleased with our global development efforts during the quarter and through the first half of the year. We opened 55 restaurants during the quarter and have more than 1,300 in the…

Great, Ashley I believe we are ready for questions.

Thank you. (Operator Instructions). Our first question comes from David Carlson of KeyBanc. Your line is open. David Carlson – KeyBanc: Hey guys hope everyone’s doing well. I got a couple of questions. Thinking of accounts from the comparability just using 2012 the marketing incentive, the 53rd week, it looks like EPS grew around high-teens 18% in the first half and guidance now suggests about 10% to 17% growth in the back half of the year. Can one of you speak, may be Lance to the reason for the more guarded outlook in the second half, especially considering it looks like cheese prices appear less inflationary. Are you seen the sales weakness third quarter to-date, are there cost issues that might be the reason for the lower [earnings] growth rate?

Hey Lance why don’t you give him some analytics and Steve or Tony you can follow up with the competitive environment situation?

Great, so I’ll start with that Dave and thank you for the question. As I noted in my script we’re confident with our full year targets and we’re tracking pretty well in-line with our internal projections which are little bit different from a timing perspective than some folks on the Street had. As you know we do have some volatility in our quarters and that’s why we got two annual amounts, not quarterly. With that said I’ll give you a few specifics here just to kind of help you work through the numbers a little bit. We were helped by about a nicked in the second quarter by tax and JV accounting items that are going to reverse in the second half. So there’s little bit of timing shift going on there. In addition as the folks on this call are certainly aware we manage our future of this business to a full year profit margin. And in order to adhere to this policy and make the amount of money we’ve committed to making to our franchisees we do expect margins to be a little lower in the second half than we saw in the first half. Couple of other items just to give you even a little more detail we entered into an interest rate swap and it locks our rate under 2.5% for nearly five years. So long time we think it’s actually the right thing to have done. With that said that does impact just a couple of pennies in the second half. And then finally again as this group is aware this does remain a very competitive category and Steve and Tony will speak to that. But as comp sales and EPS guidance should indicate we are very confident we are going to have a strong second half I should say. But as a reminder we are only half way through the year so we felt like reaffirming our guidance makes the most sense at this juncture.

This is Tony and although we don’t comment on how we are performing in the current quarter, no question it’s a competitive environment and much like we’ve seen in the recent past. So we are very confident in our marketing strategy. We take a very comprehensive approach from national all the way down to local and we work very well with our franchisees and they embrace the strategy that we are working on. And to go back on Lance’s comments, very confident in where we are going to land for the year. The other thing I would say is on the international front you are seeing the continued momentum that we have in international, achieving a thousand stores is a great milestone for us, a milestone and a beacon of where we are headed. So stay tuned on continued growth internationally.

And Dave this is John Schnatter. You have been in it a long time and pizzas at five bucks a piece that are in Dominos and pizzas, that are six [dollars] apiece give or take. In my 36 years of doing this I’ve never seen the bigger players at that lower price point. And while we are weathering the storm off-course it’s something that we are paying attention to.

And Dave it’s Steve I’ll just may just take some of that as well. I think back to Lance’s point, Tony’s point on our full year plans we are very solid. Quarter to quarter you are always going to see some variability in what you see in terms of overall performance. But the competitive environment does remain very focused in the consumer on value. I think for Papa John’s it’s how do we define value. We believe the consumer long term defines value on quality. And Papa John’s been the strongest brand in the quality and been recognized on quality 12 years out of last 14 years in the American Customer Satisfaction Index is really how you look at our business on quality, consistency and simplicity for the long term. So again just reiterating feel really solid about our full year guidance. David Carlson – KeyBanc: Okay great, thanks for the thanks for some of the clarity there. One other thing in the 10-Q it’s mentioned that bonus payouts were lower for our general managers during the second quarter. You know with the comp being up 6% was a little surprised that GMs didn’t received more of a bonus. So can you kind of talk to why that was the case?

Well Dave this is John again. First I really appreciate as investor and analyst watching out for their GM because that’s something that we are very [inaudible] to. We believe that everything starts with our general manager and he or she has to win for the enterprise to win long term. And so we are watching that very closely and Steve why don’t you give him a little bit color on why the bonuses went back at the GM level.

Yeah I will and David thanks for the question. I think again this really pleased with the corporate restaurant results, as you continue to see these, our corporate team, 11 consecutive quarters of sales growth. So just really speaking volumes to performance and leadership side and that’s really attributed to the general managers. The general managers have done a phenomenal job in executing our strategies and producing the overall solid performance. We are however growing over a huge year in 2012, specifically in the second quarter. As you just talked about variability that would create some of the fluctuations in the bonus piece. Those related pay-offs continue to be strong. However in comparison to the second quarter last year the primary reason for the lower bonus is really just a function of the quarter two bonuses being exceptional and the fact of the commodity headwinds for this year versus last year is really the primary driver that we see about 1.5% increase in food cost this year in the second quarter that’s versus last quarter second year. David Carlson – KeyBanc: Okay great and then finally was hoping you guys could speak to the potential impact that the commercial activity has had or is having on the cost of sales line?

Dave I’ll give you a kind of our perception on the consumer and their perception on pizza. And then Lance or Steve you can piggy back on the cost. Till today the pizza consumer recognizes that you give what you pay for. And a five or six dollar pizza is rolling out a pizza that reflects quality. And again we’ve being doing a long time, and you just can’t make a superior quality pizza with superior quality ingredients for a $5 or $6. It’s impossible.

Yeah Dave and thanks John for that I think that’s the point as I was alluding to you before, in the second quarter about 1.5% higher year-over-year. That again specifically related to cheese in the front part of this year versus last year the cheese is actually a little bit higher priced, at 24 cents higher in the second quarter. However the headwinds in the first half of the year have a little bit of a tailwind and the back half of the year given the future prices on cheese. So have some optimism again back to our full year guidance but again those fluctuations quarter-to-quarter being primarily commodity driven. David Carlson – KeyBanc: Thank you guys very much.

Thank you our next question is from Peter Saleh of Telsey Advisory Group. Your line is open. Peter Saleh – Telsey Advisory Group: Great, thanks. Congratulations on the quarter. I just wanted to ask about your big picture market share. Maybe you can just give us an update on where you are today in terms of the market share for the pizza category and just give us some perspective on may be where you were a couple of years ago and what’s your outlook for the pizza category or may be the next 12 months to 18 months?

I’ll give you our outlook on the business and specifically Papa John’s and then Steve why don’t you give a market share analysis. I like our business Peter and I like our business model. I think our model provides the consumer with exceptional quality and exceptional value. And I think in this environment that’s exactly where we need to be.

Yeah Peter it’s Steve. Maybe I’ll just add a little bit more color. I think just as you look at this holistically, we feel really good about pizza category in general. Pizza remains to be a very strong value to the consumer. If you look at just last couple of quarters we believe the category to be flat to slightly up which is speaking to the fact that the nationals continue, if you look at the three major players in the second quarter results, very pleased with our performance. Domino’s number showing that the nationals do continue to take away some of the sales from the regionals and the independents. And I will echo back to the corporate performance. I mean I think if you look at our corporate results those are most tenured markets and our most penetrated and have a heavier scale. We are not just the number two or three or four player, in a number of those markets we are the number one. So it speaks volumes to the long term potential on the quality platform and the potential that Papa John’s has within the category of our share.

Peter, I’ll jump in just for a second this is Lance. You know from a numbers standpoint you can look at it better just like I can and we continue to gain share and just holistically going forward we continue to open units and we continue to have positive comps and continue to grow our technology. Still we are confident that we are going to continue to steal share.

And Peter this is Tony. I’ll add a couple of comments as well. And to Lance’s point the big chains are obviously growing because of share of voice as well as share of voice media weights and technology. And as we continually talk about our leadership and the amount of online sales and digital sales that we have in our position where we are ahead and we’re continuing to grow, the big chains are much more sophisticated and we see – we are very bullish on the future of use of digital as part of our – key part our strategy. Peter Saleh – Telsey Advisory Group: Great and can you just us an update or just kind of why the company own comps are significantly ahead of franchise is there, there is something that you guys did differently? I mean it seems to be bit of a gap for the past couple of quarters now?

Steve why don’t you take question.

Yeah, Peter thanks for the question and I think I addressed this last quarter and really the answer remains the same. I mean our corporate leadership team has just done a phenomenal job at executing our operational, our marketing strategies. I mean I think just really speaking volumes to the leadership. We continue to lead and share those best practices with the franchise side of business. I spoke to the 11 consecutive quarters of core comp sales growth, it is eight consecutive quarters on the franchise side of the business. There is a gap. That gap really as you start to drill down there is variability and penetration in some of those franchise markets and the predominant amount of our growth over the last three years has been in the franchise markets. So we continue to focus on getting more penetrated in some of these franchise markets and just fundamentally believe in a long term side of our business that we’ll continue to show growth. But really speaks volumes again to the corporate side of our business in our most penetrated markets from a market share perspective we continue to lead the path. Peter Saleh – Telsey Advisory Group: Great, than just lastly from me can you talk about the partnership that you signed a few weeks or maybe a month ago in the UK? And compared to that with – if the partnership that we have here with the NFL in the U.S.?

Tony you want to take that question.

So we are very excited about our partnership with the football league. And we anticipate the same engagement with the football fans in the UK much like our partnership with the NFL. We know they are very avid fans and our footprint in the UK complements the team structure as well. So we are very excited about that.

And I will just add to that a little bit. I mean I think it just speaks volumes to the power of the brand. Papa John’s has grown significant scale in the UK in partnership. Folks are reaching out to our brand similar to the NFL. So we are very pleased with that, very early infancy of the partnership but excited about the platform and the opportunities this provides us to continue to grow in the UK. Peter Saleh – Telsey Advisory Group: And just a follow-up, will you be integrating the Papa Rewards with that as well?

Tony you want to field that question?

Yeah we probably don’t want to share too many specifics of how we are going to use Papa rewards. We already have Papa awards in the United Kingdom, but we wouldn’t want to share strategically how we would utilize that. Peter Saleh – Telsey Advisory Group: Great. Thank you very much.

Thank you. Our next question is from Mark Smith with Feltl & Company. Your line is open. Mark Smith – Feltl & Company: Hey good morning guys. Can you speak to the cadence of comps during the quarter?

Can you repeat the question please Mark? Mark Smith – Feltl & Company: Can you just speak to the cadence of comps or sequential comps month-to-month during the quarter?

Lance or Tony do you understand the question?

Yeah I do and Mark I will take that. We don’t give them month to month to month cadence we strictly report on a quarterly basis. Mark Smith – Feltl & Company: Okay. So I guess any change in the online mix?

Mark it’s Steve, and John I will jump in there.

No, go ahead Steve.

Yeah, Mark I can just tell that it remains to be over 40% and very pleased with the fact that among chains we believe we are the category leader and our online sales mix continues to be a big focus for us in the long term side of the business leveraging that technology.

And it’s, Mark this is John, it’s growing at a very attractive rate.

This is Tony. We feel like there is still significant upside in our digital sales. Mark Smith – Feltl & Company: And then lastly just on the tax rate Lance, did you say that you are expecting it to be about 33% for the year as we model should we will be looking at this as 33.5% or 34% going forward.

Mark what I did say is it will be around 33% for the year. So you can kind of work out how that has to look in the second half in order to get to that number. Mark Smith – Feltl & Company: Perfect thanks guys.

Thank you. Our next question is from Jim Yin of S&P Capital. Your line is open. Jim Yin – S&P Capital IQ: Thank you for taking my question. Can you talk little bit about your dividend initiation and what do you think your – I know that you are – and this means your financial leverage, what do you think the long-term financial leverage would be or you like to be in the future?

Lance you might field that question.

Of course. Good morning Jim. What we have already said was for 2013 we expect our leverage to be between 1 and 1.4 times EBITDA. And I think what you will see over the longer term is us continuing to balance, making investments in the business without taking the EBITDA ratio to levels that you see from our competitors. So I would expect I would probably characterize it as the 1 to 1.4 times EBITDA, signals a little bit more aggressive stance on debt than we have had in the past but I wouldn’t model it much higher than that if it were me. Jim Yin – S&P Capital IQ: Okay. And one question about international, I noticed that they would be strong. Was there any particular region than was stronger than others and likewise we see any weakness in some regions.

Tony you want to take that question.

Could you repeat that?

Jim I will take it. Yeah I think you are asking just geographically breakdown on comps. We don’t get into specifics on that. I just can’t tell you that the 6.8% comps [two euro 12.9] really represent and we get a lot momentum in the international side of the business just coming off of it in the quarter to China which has been a big focus for us as an organization. I get a lot of confidence on the momentum and the progress in the early stages of some build outs in corporate China. So from a financial perspective some short term investments with some losses but for the long term side really got a lot of optimism around the potential in a very strong country and a good brand presence as a number two player in the category.

Yeah Tim this is John Schnatter. The difference between international today versus three or four years is night and day. They just have really good product and service force, they have very consistent and it has really good momentum.

This is Tony. Just to comment on a couple of the things I said during my opening. 1,000 store opening really is significant for us I am to call that beacon of China right down the road ahead. We are very, very bullish on the future for our international business. We spend a lot of time building and working on the infrastructure and we are really excited about the work that Steve and his team have done. We’ve got a great team in place and there is a tremendous amount of upside. I have said before that runway is wide and it’s long and the 1,000 store is really is a key milestone for us that’s going to jettison us into the future. Jim Yin – S&P Capital IQ: Great, thank you for taking my questions.

Thank you. Our next question is from Michael Halen of Sidoti. Your line is open. Michael Halen – Sidoti & Company, LLC: Good morning everybody.

Hey Mike. Michael Halen – Sidoti & Company, LLC: Hi, congrats on the quarter and congrats to you, Tony well deserved.

Thank you. Michael Halen – Sidoti & Company, LLC: I jumped on late so sorry if I missed it, but can you talk about where the CapEx savings is coming from this year?

Yeah I will take that Mike. We had originally guided to 55 to 60. We have cut that down from 50 to 55. Really just not spending on the technology side quite as quickly as we had originally anticipated, but it’s really a timing shift in the next year. So kind of a timing shift, but the same spend is being spent it’s just going over two years.

Yeah Mike this is John. That was not intentional. We didn’t pull it back. We would actually like to spend faster and move faster. Michael Halen – Sidoti & Company, LLC: That’s helpful, thanks. And I guess just besides China can you talk about which countries you are going to focus your international expansion on in the back half of 2013 and 2014?

Tony why don’t you give him the specifics on country by country.

I am going to let Steve start.

Yeah, and maybe we won’t get too specific into countries but maybe only just touch on regions. I can tell you the Latin American region has been a region where we have continued to have a lot of success. The brand has been very well received. As you go country to country throughout that region that will be an area of focus. I had already kind of spoken to China in that area and then parts of Europe where specifically maybe Russia maybe I touched a little bit there. But without getting too much further in specifics those are three kind of key areas where we got a lot of optimism current success from franchise profitability perspective which we know will drive ultimately drive the development in those parts of the world.

And just to wrap up on that we are going to see a continued growth pretty much across the board, those three areas but we don’t want to dive down into specifics obviously for competitive reasons. Michael Halen – Sidoti & Company, LLC: Fair enough. And then in addition to the additional scale that you are expecting to gain now internationally is there anything going on, is there any shift in terms of the maybe giving the franchisees more leeway in terms of setting up their own menus and anything else that maybe you can point to?

Mike from the audience of kind of from a founder and the 40,000 feet and maybe let Tony maybe you can dive down a little bit into that. Probably six years ago we just really weren’t making the pizza the way we made it in the States and we let international franchisees have probably little bit more leeway in doing things not the Papa John’s way. And what we discovered through the school of hard knocks is that the brand the way we run it in the U.S. works throughout the world. And that was an insight that was kind of wow. And so the last three or four years we have actually reined in the franchisees on getting too far out of the guard rails on what is Papa John’s way. And I can tell you the product quality from Chile to China to New York is the same throughout the world. And that’s taken a lot of hard work that Sean Muldoon and our great R&D and QA teams that have really implemented what we really call the gold standard. And as far as menu I will let Tony answer it but we are actually going the other way. We are reining them in, trying to be more like the Papa John’s in the U.S. than we are letting them things that are kind of out of the box. Tony?

Thanks John. Michael back to my comments on infrastructure and the work that we have done over the past several years in international our focus on process as well as product has been really, really at the top priority for us. So to John’s point that he just made about reining in, Steve said earlier our focus is on quality, consistency and simplicity and that speaks to the menu. Obviously from an economic model standpoint it needs to be have that sweet spot of restaurant efficiency and certainly our quality standard. So the menu is a key part of that, wouldn’t want to give too much detail other than that but our focus has been to bring our brand back to center of who we are as Papa John’s and that’s what John was alluding to over the past several years. So we put process and infrastructure in place now to help manage that a lot better and I will echo John’s comments because the leadership team goes around the world now few times a year and our consistency of our quality, standard of our product is phenomenal and it’s great for us to take John around, as our Founder and as the ultimate litmus test of that and it’s really exciting the progress we’ve made and go back to everything we’re talking about domestically. Our quality position is who we are and that’s what’s winning the game and we know that’s going to be the winning hand around the world as well as we continue to do so domestically.

And Mike this is John again. We probably have 100 things in the pipeline that we think to make the company better in all disciplines. And believe or not after 29 years we’re still figuring out how to get more consistent with our products and have higher quality throughout the system. So we’re still getting better, we’re still learning. Michael Halen – Sidoti & Company, LLC: Great. Thank you guys very much.

Thank you again ladies and gentlemen. (Operator Instructions). I am not showing any questions in the queue. I’d like to turn the call back over to management for any further remarks.

Great, Ashley, thank you very much and thanks to everybody for taking time and being on our call. Have a good day.

Thanks everyone.

Ladies and gentlemen, thank you for participating in today’s conference. This concludes today’s program. You may now disconnect. Everyone have a great day.