Papa John's International, Inc. (PZZA) Q3 2013 Earnings Report, Transcript and Summary

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

Thank you, Tamara (Ph). Good morning. With me on the call today are Founder, Chairman and CEO, John Schnatter; President and COO, Tony Thompson; SVP of Global Operations, Steve Ritchie, who is joining us from Dubai this morning, 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 the 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 Q3 operating results; for the third quarter our diluted earnings per share was $0.65, up 18% and our year-to-date 2013 diluted EPS was $2.27, an increase of 23%. Our third quarter revenues increased 6.4% primarily due to comparable sales of 1.8% for North America and 8.1% for international.…

Hey thanks Lance and good morning to everyone we appreciate each of you taking the time to be with us on the call today to discuss our third quarter results of 2013. I want o start off as customary by congratulating our franchisees and operators throughout the world on another strong quarter from sales to international momentum to EPS growth this was yet another solid fundamentally sound quarter paving the way for future continuing momentum. Much like it was through the first half of the year, the global operating in competitive landscape remained challenging in the third quarter. However, by being solid at the fundamentals and focused on consistently delivering on our better ingredients better pizza brand promise each and every day we were able to continue our momentum through the quarter and position ourselves for a strong close to the year. One of the areas that continues to be a bright spot for Papa John’s is our international business, which performed very well during the quarter. As Lance noted our international franchisees turned in at 8.1% comp which up lead to improved operating income for the quarter. Driving those positive comps in part is the fact that our international product and service scores continue to reach all time highs; it is clear that our international franchisees and operators continue to fully embrace doing things the Papa John’s way in every aspect of the business. In many respects, our franchise’s strong consistent operations helped increase the demand for our product around the world which ultimately leads to restaurant growth. This formula helped us exceed 1,000 international restaurants during the second quarter a milestone we celebrated last month in London very few brands in any industry have opened 1,000 stores internationally so we view this as a significant event and a springboard to even greater international growth. Next I would like to comment on the decision by our Board of Directors last week to initiate a two-for-one stock split which Lance just mentioned since I found this company nearly 30 years ago I have always preached a sound steady financial approach to building the company the stock split reflects the strength of our brand and our commitment to an increasing shareholder value. Finally I would like to personally welcome Bob Kraut to our marketing team he is our new Chief Marketing Officer. Bob is an innovative marketing leader who joins Papa John’s with a significant QSR experience, we are excited to have him on board and I personally look forward to working with him on taking our brand to the next level. With that I will turn it over to Tony Thompson for his comments.

Thanks John I also would like to start by congratulating our system on another solid quarter. With a continuing sluggish global economy and a challenging competitive environment our system showed once again the positive impact that focusing on the fundamentals can have on our business. As Lance mentioned we are very pleased with another quarter of strong financial results with EPS up 18% and revenues up 6.4%. This as a testament to the focus and commitment our operators around the world have to deliver on our better ingredients better pizza brand promise each and every day. Another driver of our strong quarter and year-to-date results is our industry leading digital ordering and marketing efforts. As I think many of you know John has always had a keen insight in the consumer trends with an unrelenting focus on giving consumers what they want. And those consumers have told us Papa John’s is number one in customer happiness by ranking us number one for 12 out of last 14 years in the American Customer Satisfaction Index. As a visionary, John recognized very early on that customer ordering habits were likely going to change with the rapid growth of the Internet as a result in 2001 Papa John’s was the first pizza company to offer system-wide online ordering in all of our U.S. restaurants in 2007 Papa John’s was the first to tap into consumer mobile trends nationally with system-wide SMS text ordering. And then in 2010 Papa John’s was the first and is the only pizza company to date to launch a digital rewards program Papa Rewards. And just last week on Halloween we tucked $5 billion in total all time system-wide digital sales. As a result of being on the leading edge of technology Papa John’s e-commerce business in the U.S.…

Tamara, I believe we’re ready for questions.

(Operator Instructions). And our first question comes from Michael Halen with Sidoti. Your line is now open. Michael Halen - Sidoti & Company: Can you give us some color on the high rate of North American franchise, unit closures in the quarter?

This is Tony. I will start, well first really nearly half of those closures were due to a couple of five to 10 store operators that they were closing struggling units and underpenetrated markets. And then we had several low impact non-trade units that were closing, that they close. So we remain on track with our longer term development plans and the overall health of the system is solid, but we needed to adjust our original guidance as overcoming these closings we knew to hit our numbers was not realistic. Michael Halen - Sidoti & Company: Also the cost of sales at domestic company owned restaurants increased at a pretty good clip in the quarter. Can you give us a little bit of color on that as well?

Sure Michael I will start with that one and then I will let Tony in or Steve jump in or John if they like. Couple of things going on there, first of all commodity, there was little bit of commodity pressure mainly from dough boxes and meat. You probably noticed cheese prices on the block were relatively consistent for the quarter. We did - as you know we do some direct contracting with our cheese that helped us little bit in the second quarter or in the third quarter of 2012. We did not get that same help this year. And then we had a little bit of margin pressure related to some limited time strategic marketing national promotion. So with that I will let some others jump in here.

This is Tony, and I think I have mentioned on prior calls we're going to deliberately and strategically go and use aggressive promotions in price point with the right time and cause.

Michael this is Steve, I will chime (Ph) in just for a moment I think really first off very pleased with the corporate restaurants 5.1% sales growth that kind of continues to remain our overall strategy for the corporate restaurants. As you see we have had some spread between our corporate and our franchise restaurant sales performance, but both of them pretty since 12 consecutive quarters of sales growth. So that will remain the overall strategy where we will continue to see some variability from quarter-to-quarter on margin pressure. But as Lance and Tony both alluded to you, some of that driven - some of that commodity piece and the variability in the local or national pricing, but overall pretty strong performance. Michael Halen - Sidoti & Company: And my last one, I was kind of surprised that you didn't draw it down on the revolver to report purchase more shares in the quarter than you did. Was this a response to the stock price and you still project a long term debt to trailing 12 month EBITDA ratio of 1 times to 1.4 times at the end of year-end 2013.

Mike this is Lance I will take that one. We do in fact still expect to be between 1 and 1.4 EBITDA that more kind of timing issues than anything else relative to the repurchases this quarter [indiscernible] changed the long term plans there.

Thank you. And our next question comes from Peter Saleh with Telsey Advisory. Your line is now open.

Thanks and congratulations on the quarter end a year. My question is on the international side, the unit growth guidance was up pretty dramatically to 160 to 180 pretty significant increase. So I guess given that so late in the year my question is where are these incremental units going to be built? And is this a pull forward from 2014 where we would expect 2014 development to be lower, because you are pulling it forward or how should we be thinking about that?

Peter this is Tony. First we typically don't give any detail around where those openings are going to be. But I think if you look at the typical pattern over the last couple of years, we tend to be a little backend loaded in our openings. So that's fairly consistent and we’re not going to get into 2014 guidance yet. But what I would tell is consistent with our overall plan for development and openings and without giving too much detail on 2014 or not necessarily though pulling forward from our long term plan.

Peter its Steve, just a comment on that, I just wanted to touch on this. I am really proud of the corporate team and the international side of the business at this time versus last year we’re about 68% ahead of our net unit development year-to-date, so just showing that continuous momentum that we have. And as Tony alluded to we continue to have really powerful openings in the fourth quarter.

And on the comp internationally again fairly strong, any comment around the U.K. market and how that’s dealing or what the real drivers of that 8% comp were in the quarter?

I’ll start Peter. This is Tony. We’re certainly really proud of our UK team and the growth and the positive momentum we have in that market. As a matter of fact I think you probably saw that John and I were over at London celebrating our 1,000 store celebration couple about last month, and that team is just really, really doing a great job over there I wouldn’t want to give a lot of details as far as from a competitive standpoint but we’ve got great momentum and the future looks really strong in the United Kingdom.

Peter, this is Lance, if I could jump just for a second. Well, we’re not going to give country-by-country I can’t say that the strong comps are spread relatively evenly throughout the world don’t mean you don’t have some markets that are doing better than others but it is consistent across the entire world.

Peter, this is John Schnatter, the difference between the UK four years ago and today is night and day. It’s a real business. It’s run extremely well. We’ve got fantastic leadership and just a lot of momentum.

Thanks a lot, and then Lance just on the operating cash flow for the year. I know for the nine months there is some working capital issues I guess reduce the cash flows versus last year. For the year in terms of operating cash flow how should we be thinking about that? Are these just timing issues in the third quarter and should it more normalize into the fourth quarter?

Peter, this is Lance. So couple things there. The CapEx we’ve been guiding all year that this is going to be a little bit higher than you’ve seen so that’s certainly a component that is bringing down that free cash flow a little bit. On the operating side, it is mainly timing but I’m not going to get into specifics relative to if it’s going to look exactly like it did last year or whatever. But there are some timing issues in there particularly around just timing at some income tax payments and what not.

Peter, this is John Schnatter to expand on that little bit. We look at depreciation and amortization as a real expense. We believe and big deep and wide modes around the business to protect the business model. So we build an extra capacity, strong redundancy and we over ensure we think that promotes a conservative approach to driving consistent financial results.

Great, thank you very much.

And our next question comes from Mark Smith with Feltl and Company. Your line is now open.

First off, Lance, it looks like you’re guiding tax rate kind of 32-34, I know you haven’t given next year’s guidance. But can you give us any reason that tax rate should change going forward out of that kind of historical range?

Mark, it’s Lance again. It’s actually 32 to 32.5 is what we’re saying for the full year this year and to your point while we haven’t given ’14 guidance yet there is no significant things coming down the pipe that ought to change that rate by a significant amount. It is little bit lower this year so I would encourage you to wait for the 2014 guidance. But there is not a huge swing that I see coming on.

And then if you guys can talk to the strength of your franchisees, we saw a little higher closures domestically this quarter than expected comp was maybe down compared to the trend. How do you feel about the strength and the health of your franchisees today?

This is Tony, and I’ll start, and I’ll let Steve chime in as well. We monitor our franchisees very closely, and we are very engaged with our franchisees. We actually just came back from a four-city road trip where we’ve met with the majority of our domestic franchisees a few weeks ago. And we’re constantly working with them on sharing best practices and certainly leading by example with our corporate team. And really the net impact on - if you look at success and profitability, opening stores and growth is the best litmus test for that. And we are seeing continued growth within our domestic business. And certainly the business is a challenge right now and there is still a very sluggish economy and the system operates as a whole and as one unit so that’s very, very important to us and the relationship with the franchisees is really critical. Third quarter was a challenging quarter or something that nothing that we didn’t expect. And as you saw we put in place a couple of incentives that historically we said we’re going to be very strategic delivered on use of incentives. So in the third quarter we did that and think that has worked well to our plan. And Steve you want to make a few comments?

Sure, Mark, it’s Steve, just a couple of things to add on it. I think the one as Tony has alluded to you; nine consecutive quarters on the franchise side of the business are positive sales growth. So, that’s been our overall strategy to grow market share and there is a direct correlation between sales growth and franchise and profitability, without a doubt three consecutive years of record commodity prices and extremely challenging price in competitive environment is going to provide some pressure in some of those underpenetrated markets, some of the closures. However, a lot of the sales growth that we are experiencing and the unit growth are in those underpenetrated markets. So we’re in parallel strategies to really ensure we get the right long term plan.

I’ll let Bob Kraut, after five weeks will give you his commentary on the brand. You can’t have great numbers long term without a good brand. You have to have a good brand, to have sustainable long term numbers and I’ll let Bob talk to the brand.

Just a couple of things regarding the brand, I think it’s extremely healthy there. There are three fundaments that we have in place that are great strengths. Number one; the quality positioning and the consistency of execution of better ingredients, better pizza. The number one ranking in customer satisfaction or as we call customer happiness which is just not one year an event; it’s happened 12 times out of the last 14 years. And then the strength and I believe we are the acknowledged leader in digital ordering with as Lance mentioned, 45% of our sales occurring through digital ordering. That’s a great place to be, it’s a great place for me to be kind of coming in and trying to take the marketing effort to the next level and I think what you can expect from me is really sharpening the focus in terms of resources and commitment of resources and taking advantage with regard to customers, their growing use of digital and social media which for us is I think a pretty quick pivot point since we’re already well established in those areas. And then of course, we being the official pizza or being NFL I think is been a quite visible statement of our leadership in marketing and our coming off the age as a very well positioned, big brand that customers trust. So, I’m looking forward kind of getting through this period of study and just taking the marketing effort, taking the great base that I’m inheriting and taking that to the next level.

Mark, one more comment along these lines in addition to the great partnerships and marketing assets we have our brand position really helps us in this type of environment. Pizza is a great value which I noted that before and the fact that it is a great value, people are going to chose better and they’re going to chose, if they have quality choice that’s what they’re going to go after and that’s something that we consistently, that's our key part of our marketing strategy and most importantly from an operation standpoint our team members focusing on execution of quality and service that’s what it’s all about at the end of the day.

Your comp guidance for the domestic stores is pretty strong, I guess little higher than I’d expected here for the year taking a higher, it implies that you’ve got a pretty good fourth quarter built in, I’m curious what gives you the confidence in domestic comps given, we’re just on third quarter from the franchisees, you know that you can achieve 2.5% to 3.5% comp in Q4. Have you seen something in, I know you don’t like to speak in cadence but you’ve seen that trend really improve through October or is there something later in the quarter?

You know we don’t give quarterly guidance so we felt like maybe the stream was a little lower in Q3 or little higher in Q3, and a little lower in Q4 and its obvious in our raise in the yearly estimates. But to your point, the business is quite predictable on the short term but as you mentioned like all the businesses this is not quite as predictable on the long term. Therefore the shorter the timeframe, the higher our probability of predicting results assuming that something severe doesn’t happen. So we feel very good and very solid about our guidance with only month and half to go with the year.

This is Tony to follow that, the key word that we keep coming back to is momentum and strategically in the third quarter as I mentioned earlier we put in from incentive that we’re planned to help with the momentum. In a quarter we knew and expected to be a challenge and as we coming to the fourth quarter for remainder of the year again we’re always looking longer term we want to maintain that momentum and we feel good about our position or strategy.

Thank you. And our next question comes from Mr. Chris O'Cull with KeyBanc. Your line is now open.

John, the company on stores comp 5% but the store profit dollars were down. Do you think the focus on growing transactions is a profitable venture for the franchisees who aren’t comping up as much?

Again, this is John, Chris. The corporate system is having probably the best year they ever had and the franchisees that really know what they’re doing and they execute and get up every day and run the business the Papa John’s way or having record years. All that Steve or Tony jump in to give some color to the transactions versus the profitability question.

I will jump in first and then let’s Steve follow. This is certainly driving top line sales, it’s critical and important. The other that we’ve talked about early was driving digital sales as well and where we’re with our digital mix. There is certainly a lot of benefits from that we’ve talked about on frequency. The difference in ticket average that you can get on digital, so that is a real important part of our overall strategy condition to drive top line sales and this environment that works well for us, so, Steve I will let have the comments.

Yes, Chris thanks for the question. So first I’ll catch on corporate and I can tell you and we’re continue to say this long term our strategy will remain driving market share and driving market share through traffic growth. Our corporate restaurants have proved out that model as to John alluded another record profit year in the making. It touched on the 5.1% comps in the one year on the corporate side, and on three year basis where it’s 16.4% three year comp for the third quarter. So the corporate restaurants are providing a roadmap to success for the franchisees. Our franchisees as a whole are experiencing the same kind of traffic and sales growth, not the same significance but the same kind of consistency. So it’s the old 80/20 rule, we do have 20% of our franchises that we continue to work on by providing those best practices on the corporate side of the business. So, I think as a whole profitability is always going to remain a focus in the restaurant industry and it certainly is in this environment, but overall very pleased with the progress and resiliency of our franchisees.

And I may have misspoken, I understand the sales volumes of corporate stores are up quite a bit, but it doesn’t look and I maybe wrong about this, but doesn’t look the profit dollars for the corporate stores are up and that surprises me given that the size of the comp growth. I would think the profit dollars per store the corporate stores would be up more.

Chris, this John Schnatter. We don’t want to operate in a vacuum. The competitors are down in the $5 to $8 pizza range, so that’s something we can’t ignore. Furthermore, this is probably the most rugged commodity market in the history of the company. And so there is not a resultant business out there, there is not feeling of this cost environment.

I think, Chris, I’ll jump on that again. We touched it earlier and you heard it as we talked about Lance providing some direction on the pricing that we did have some variability in our national to local price in the third quarter that did provide some menu mix pressure to the corporate restaurant side of the busies in the quarter. So again we look at the business long term on annual basis as you look quarter-to-quarter, you will see some variation with that menu mix that did drive a little bit lower profitability in quarter-over-quarter comparison, but the full year picture on our guidance looks very strong.

Lance, in the fourth quarter I know last year there were several big moves at the store level cost especially around labor, do you expect the company store margin to be down at a similar rate in the fourth quarter as we saw than the third?

Chris, this is Lance. We are not going to give probably that exact guidance. For the fourth quarter, I think what I can say and John or Tony and Steve can to add to this if they would like to. The competition is going to stay tough. The market is going to stay tough. We are going to get some help frankly from cheese versus last year to the ton of about $0.13, last time I looked on the commodity side. So you may get a little bit help there but I would suspect overall, it’s going to remain competitive.

Chris, this is John Schnatter, and I will hit this one more time. I think we have risen estimates last four out of six quarters. As a founder, I am very happy with the last two years profitability in the restaurants and I am extremely proud of the year we’re having with Steve and the entire operation team from corporate basis, and going in ’14, I have seen some preliminaries that I feel very good about our profitability going in to ’14.

John, do you expect change the national ad contribution rate in ’14?

Like national marketing?

Yes.

No, there is no plan change for that in 2014, this is Tony.

Okay great, thanks Tony.

Thank you. And our next question comes from Jeff Blair with Analytic Capital. Your line is open. If your phone is on mute, you want to try un-muting it. It looks like he disconnected. (Operator Instructions) Okay next question comes from Charles Temel with UBS. Your line is now open.

In contrast to your U.S. marketing strategy which is very John focused and sports focused I was wondering if you could comment on your international marketing strategy where you are going across countries and cultures. UBS: In contrast to your U.S. marketing strategy which is very John focused and sports focused I was wondering if you could comment on your international marketing strategy where you are going across countries and cultures.

This is Tony I will start and let Steve chime in since he is actually over in Dubai as we speak. First our brand positioning globally really is very consistent. We utilize John in our creative in our imaging and our marketing that we local store we are primarily we go into markets and local store marketing is our push initially we do it the same way we spent the last four years really working on our international business and treating it as a global business so we went and we focused on our product our store operations and our marketing. And so today if you were to go to Beijing you are in Dubai you are going to see and feel a have a Papa John’s experience that’s just like it is in the U.S. So from a branding standpoint we are consistent in our approach certainly from a media stand position you go into a market you are not going to have the media benefit that we do domestically but the same approach that we took as when John started the business as a local store guerilla tactics going into a market, the strength of the brand the quality of the product and the execution and the operation is really key and central to our success and we talked about the United Kingdom earlier as a great example of a market that we have grown in a very, very competitive arena and have been extremely successful and that’s what’s happening around the world and I will let Steve elaborate.

Yes tony thanks for that and Charles thanks for the question so to your point I think Tony covered a good amount of that I will touch on the sports piece and I will use the UK we think it’s a great example we signed up the NFL sponsorship as you are well aware of in the U. S. We did give an announcement earlier this year. We are now the official pizza partner of the football league in the UK with our 72 clubs and annual attendance of 16 million and that’s just a great example of those following U.S. best practices and leveraging those across all international marketplaces and I can tell you we are in the strategic planning sessions from a marketing perspective here this week in Dubai with all our Middle Eastern and Europe markets and really most of the things that I saw over the last couple of days are U.S. best practices. So to Tony’s point we don’t have big national media TV budgets but what we do have is strong local store marketing tactics and execution and it really remains the same focus on quality execution of products all our operations all our customer service with great roots on the ground so hope that answers your question.

Charlie this is John not to be redundant but what you just said on is very, very important we the brand is very, very consistent worldwide and whether it’s our gold standard with our product and gold standard with our marketing we are very, very consistent and the competitive advantage we and the demonstrable difference we have in our product in our marketing in the U.S. is actually exacerbated worldwide in other words the difference between us and our competitors on product and image worldwide is even stronger than it is in the U.S. because we have spent the money and we have taken the time to implement consistencies through the gold standards on both marketing and product.

And John also we look forward to you throwing the first pitch at a Yankees game now that you are the official pizza of the New York Yankees. UBS: And John also we look forward to you throwing the first pitch at a Yankees game now that you are the official pizza of the New York Yankees.

Glad to see you got that, you saw that news.

Thank you at this time I am not showing any further questions.

Great well Tamara thank you and thanks to everybody for taking time to be on the call. We will talk to you in a few months.

Thank you ladies and gentlemen thank you for participating in today’s conference this does conclude the program and you all may disconnect everyone have a great day.

Thank you, Tamara.

Thank you.

Thank you.