Papa John's International, Inc. (PZZA) Q1 2013 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to your Papa John’s First Quarter 2013 Conference. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will follow 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, Mr. Lance Tucker. Mr. Tucker, you may begin your conference.

Great. Thank you, Melba. 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; and other members of our 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 Q1 operating results. We’re pleased to report that we started off 2013 with healthy earnings and comps and a strong pizza category. We earned $0.85 per share in the first quarter, a 23% increase over $0.69 per share in the first quarter of 2012. Excluding the impact of the marketing incentive in both years, EPS increased to…

Thanks, Lance, and good morning to everyone. We are glad you took the time to be with us on the call today. I will begin by congratulating our franchisees and other operators throughout the world on another solid quarter. As Lance noted, we are off to a nice start in 2013 with good comp sales, EPS and unit growth. The environment remains challenging, but our operators continue to consistently execute our model of delivering a better quality Papa John’s pizza with an industrial leading customer service. I am pleased to say that not only our number is strong, but our pizza quality and customer service has never been better. Next, I would like to briefly comment on our international business especially our outstanding performance in the United Kingdom. Our international business continues to steadily growth and we expect to reach store 1,000 for international this summer. With over 8% comps in the first quarter, including great performance out of the United Kingdom, we couldn’t be more excited about the future of our international business. I would also like to comment briefly on our marketing and branding. As you know, last year, we extended our NFL partnership and that relationship continue to pay big dividends for us in the first quarter of 2013. Our Super Bowl coin-toss promotion and marketing campaign, which featured Peyton Manning, proved to be very popular with consumers again this year. And we’re also, of course, thrilled that Peyton is the franchisee of Papa John’s in our Denver market. Finally, as founder, I continue to be pleased by the pride and dedication I’ve seen from operators throughout the world. Product quality and customer service has never wavered in the face of a challenging operating environment over the past several years, and for the first quarter of 2013, it was no different. In fact, I think, it’s worth repeating – our product and quality service scores are at an all-time high. I’m particularly proud of those accomplishments, because our operators have been meticulous about the fundamentals to achieve these scores in a very tough competitive environment while offering the category’s premium product. And that, along with constituency, is part of a winning formulate that has made Papa John’s so successful for almost 30 years. From day one I’ve founded this brand, a consistent, disciplined, rigorous approach has served us well in every aspect of our business from EPS growth to restaurant growth to sales growth and will continue to guide us, as we grow scale and execute against our long-term plan for growing Papa John’s throughout the world. With that, I’ll turn it over to Tony Thompson for his remarks. Tony?

Thanks, John. I too would like to congratulate our system on a strong quarter. As John noted, our operators’ focus and commitment to quality and delivering on our “Better Ingredients, Better Pizza” brand promise enabled us to continue the momentum we built in 2012 into the first quarter. In North America, our operators posted a 1.6% positive comp sales performance during the quarter, including a solid 3.9% positive comp sales increase for our company-owned restaurants. Our three-year comp sales for the quarter were a positive 8.8%. Of note, we continued to benefit from our digital investments with digital sales well over 40% in the first quarter. Our international operators posted an 8.2% positive comp sales during the quarter and a positive 22% on a three year basis. Our quality position continues to resonate with consumers around the world. The results of our continued focus on the fundamentals and consistently executing the Papa John’s way continued to show themselves in our strong sales comps. I would note this first hand during the quarter as members of our leadership team visited several markets throughout Asia including China, Korea and the Philippines with a stop in one of our newest markets Guam. At each stop we met engaged and enthusiastic franchisees and operators, who were making Papa John’s signature better quality pizza and executing the Papa John’s way. Not only that our international operations executing and delivering quality at the highest levels, our consistency from country-to-country and city-to-city is outstanding. We are very bullish on the future of Papa John’s International operations and the runway we have for continued growth as we expand our better ingredients, better pizza, and brand promise. Much like our sales we continue to see momentum in a restaurant growth in both North America and throughout the world. As Lance mentioned, we opened 34 net restaurants during the quarter, 17 each in North America and abroad. We currently have more than 4,200 restaurants opened in 34 countries and our prospects for continuing to grow the Papa John’s brand throughout the world are very promising. Our development pipeline remained strong as well with over 1,200 restaurants in the pipeline scheduled to open over the next six years. I’m excited about the long term goal and prospects of the Papa John’s brand. Finally I would like to touch briefly on our franchise relations. During the quarter, we met with numerous franchisees during the week long road trip throughout the country with stops in Cincinnati, Atlantic City, Atlanta, Jacksonville, Dallas, Las Vegas and Chicago, and again recently at our annual operators conference. The passion for the brand and the spirit of collaboration is at an all time high and collectively we have the system planned for continued growth and success. With that, I’ll turn it over – back over to Lance for questions.

Melba, I think, we’re ready for Q&A.

Thank you. (Operator Instructions) And our first question comes from the line of Michael Halen from Sidoti. Your line is open. Sir, your line is open. Michael Halen – Sidoti: Good morning. Thank you very much. Good morning, everybody.

Good morning.

Good morning. Michael Halen – Sidoti: Can you give me a little more color on international, I guess particularly in China. I know, it’s probably difficult to gauge for you, but do you think you may be gaining some momentum there at the expense of Yum Brands?

I think – this is Tony, by the way. Michael Halen – Sidoti: Hi, Tony.

Good morning. The way I would answer that, I – really we’re focused on just our play and our strategy in China, and overall there is – it’s a big market in China. And our Beijing results and Tianjin, Shanghai are doing extremely well. I wouldn’t necessarily say we’re benefiting from what they’ve experience.

Michael, this is John Schnatter. There – the pizza restaurants over there are little bit different, some probably are bigger, kind of like a TGI Friday. They do have a Delco model, but most of the pizzas are pretty big. So I wouldn’t say we’re taking any market share away from Pizza Hut. I would point out that the success we’re having in Beijing is a big deal. We’re – we’ve got the service part of this down. We’ve got the product quality part of this down. And we now have the right model in place to be successful. The kind of a little bit of a backward momentum you see in profitability is completely predictable because, remember, Beijing is a big, big market. And if you do a licensing in Kentucky of, say, 10 stores, you can do that rather quickly. If you do a Nashville, 30 stores, that takes a little more time. And if you do a Dallas, let’s say, 60 stores, that’s even a little bit bigger task. And if you do Atlanta, which is 120 stores, that even takes more time and more capital. And so, in Beijing, we’re at 50 stores, headed towards the 100. And we have to bother a little bit on the profitability, but the main thing is we do have the model figured out and we have fantastic momentum. And that’s the key. Michael Halen – Sidoti: Great. Thanks. And then how long do you think it will take you to get to 100 stores in Beijing? Tim O’Hern: Good morning. This is Tim O’Hern. I would say, some time probably in 20 – late 2014, early 2015 probably. Michael Halen – Sidoti: Great.

And, Mike, this is Lance. That will bob around a little bit but ‘14, ‘15, something in that range. Tim O’Hern: It’s Tim, again. As John indicated, it takes time to work in a big model – big market to establish a good base of stores that are clustered well, put together well, that operate consistently, and we’re going to go at this methodically. Michael Halen – Sidoti: Beautiful. Thank you very much.

Our next question comes from the line of Chris O’Cull from KeyBanc. Your line is open. David Carlson – KeyBanc: Hey, thank you very much. This is actually Dave Carlson. I am from Chris here. Hope you guys are doing well.

Thank you.

Thanks, Dave. David Carlson – KeyBanc: Couple of questions and then I will get back in the queue but my first question regards to the outperformance of the company source relative to the franchisees. I think Tony was speaking in terms of three year comps a few minutes ago. And that spread is widened over the last year it looks like what the gap really accelerated significantly in the first quarter. What’s really driving this level of outperformance?

Dave, its John Schnatter. Great question. I headed at a high level and turned it over to Steve and Tony. And they can give you a little bit more detail. We feel most fortunate that we’re having such fantastic corporate success. And the franchisees are also seeing, what you just noted. And the fact that is corporate performance exceeds the franchisee performance not only in comp sales but in just about every single matrices and I think we’re the only franchise system or the franchisee or outperformance of franchisee. So they are starting to ask the question. What you guys doing, so we’re sharing with them what we call a comprehensive approach, which is something we’ve been doing and implemented the last four, five years. And it’s all about shared best practices but Steve I’ll let you hit the detail now.

Yeah. Thanks, John and thanks Dave for the question. I mean I think obviously we like to look at the business in the long-terms. So just a couple of key highlights I kick it off and maybe I will give you some factors. For one, if we look at the last ten quarters, both the corporate and the franchise side of business ten consecutive quarters or positive comp sales growth. So showing growth on both sides of the business and they dig even deeper over the last 20 quarters on a five year basis, 18 of those 20 quarters on the franchise side of the business have been positive. Conversely only 13 out of 20 on the corporate side so that speaks to the momentum recently that we’ve gained in the corporate side of the business is really in the last three years. Three key factors that I want to share with you here is our corporate stores are in predominantly more tenured and penetrated markets with varying levels of locals for marketing. Number two, as John has kind of speaking to the talented field leadership within the corporate team has been very effectively demonstrating their build to integrate all of our proven marketing, operations and technology strategies across the board in all of our 600 markets. And then lastly, there certainly has been some benefit from our acquisition of the Denver and Minnesota markets that took place in Q2 of last year. And we’re very pleased as we don’t get into specifics, but very pleased with the progress being made in those markets. What I’ll say is over time, we are confident and have proven that our branch trend with a consistent focus on the fundamentals of the business, not only creates success in North America, but will create success in every market around the world.

And Dave, this is Tony. One of the ways we actually demonstrate and show that leadership with our franchisees is we go out on what we call a road trip as I mentioned in my script. And we go out and spend time in – regionally across the country with our franchisees. And demonstrating and showing the things that we’re doing, sharing best practices and certainly we learn from them as I’ve said on the previous calls. But really showing the way and leading the way. And we actually that’s why it’s also important, we were talking about China a minute ago, international front of having a strong presence in China and having that corporate leadership internationally as well in a very, very important market. David Carlson – KeyBanc: Okay. Great, great answer. The other question I had was it goes back to a few minutes ago, the question on the international segment. Given the strong comp performance there, when do we expect to start seeing margin expansion at the international segment? Is it the matter of continuing the build out of the China segment? When do we really start seeing the margin get going?

David, again, this is John. I’ll hit it at a high level and then let Tony give you some color. I looked at where international was four years ago and where we’re at today and it’s just night and day. The success we’re having at Latin American is just tremendous. The United Kingdom in 2010, I think that market lost $3 million or $4 million and now it’s profitable with tremendous momentum with great leadership. Russia is on fire. And so we have pockets of opportunity. But all in all, five years ago I just didn’t the light at the end of the tunnel with international. And the progress we’ve made again on food quality, food service and just the entire experience with the customer, the Papa John’s way is alive and well and it does work on an international basis systemically. We’re just having a lot of success. Tony, why don’t you hit that and then John you might talk a little bit about some of the gold standard we’ve done on products worldwide.

Sure. And – this is Tony. We’re really just getting started internationally from our vantage point. Runway is extremely long and wide, so we really feel good about it and bullish about it. And as we look at quarter to quarter given our current position and our trajectory, we’re going to see some differences in quarter between pace investment as we’re ramping up on profitability, certainly within our corporate restaurants, but as we enter new markets. So we’re going to balance that pace with investment as we move forward so you’re going to see maybe some quarter-to-quarter ebbing and flowing on profitability, but this year from a guidance standpoint, we feel really good about this year being equal to last year in terms of profitability.

This is Lance, so let me jump in at least kind of said this year should be at least equal to last year profitability international and we expect that actually to be higher. So our overall guidance is $2.90 to $3 that includes some good growth on the international side. David Carlson – KeyBanc: Great.

This is John again, and I’ll let one Shawn jump in. Being the founder of the most important thing to me is of course the people and the product and the progress, so I want to jump in on the progress. We’ve made international because the product quality is exceptional from a global basis.

Sure, John. Thanks. We’ve got a lot of great momentum over the last four years in terms of our gold standard. We established our gold standard about four years ago in terms of trying to make every market internationally meet the same center, so we have here in the U.S. We made a lot of progress over the last four years in terms of converting stores and markets to our gold standard. In fact, if you go internationally now from dough, sauce, cheese all of our core ingredients they look in terms of mirrored image exactly like they do in the U.S. with very few exception, so a lot of great momentum in terms of gold standard. David Carlson – KeyBanc: Thanks for the response guys. I’ll hop back in the queue.

Our next question comes from the line of Mark Smith from Feltl & Company. Your line is open. Mark Smith – Feltl & Company: Hey, good morning, guys. Just a couple of quick ones. First, I want to dig a little bit more into the domestic comp. Can you talk at all about pricing versus traffic and also the cadence of comps whether they got better through the quarter or fairly flat kind of how the comps worked out through the quarter?

Yes, Mark, it’s Steve. And I’ll try that one and maybe the other guys will jump in. Obviously we don’t speak specifically into traffic gains. As a whole, what I will say, we are pleased with our traffic progress over the last couple of years and certainly the dynamic and balance of how we look at pricing, with how we look at the competitive environment related to the consumer and pleased overall with our quarter. I think we spoke to in the last quarter, the mindset of the consumer being in a cautious mode and certainly, so as we look at – speak period to period, but as we look at how the period was made up the fact that as we spoke to last quarter around the delay of the income tax piece on the returns, the increases in payroll tax, the fuel prices impact on our consumer. But as you look at our fourth quarter, certainly pleased with our overall dynamic in terms of strategy and how we looked at our pricing and how that created overall results. Mark Smith – Feltl & Company: Perfect. And then maybe for Lance, I just wanted to walk through a little bit on the interest expense and just make sure that we kind of got your – from your commentary and are looking at the right way, kind of how should we be modeling that interest expense through the remainder of the year?

You know you saw it actually be, Mark, a net interest income number for the quarter, we got a couple of pennies benefit from the joint venture accounting we do, expect that to be neutral for the entire year. So that should tell you that we will give a couple of those pennies back on that accounting that all runs through the interest expense line. So I’d really be more focused on what your estimates of the interest rate and debt are going to be. And over the course of the year, the JV accounting should really have very little impact although it did help us to the tune of a couple of pennies in the first quarter. Does that help you? Mark Smith – Feltl & Company: Yeah. That definitely helps. Thank you. And then last question just – I know you guys talked a little bit about it, but can you talk more about kind of your expectations for use of cash, especially with the new line of credit out there and especially buybacks? You said you’d be about flat with ‘12. And when you do come to the end of the authorization, I want to say that’s in September, do you think you’ll have any issues of getting the Board to re-up on that?

Mark, this is Lance, again. Two things. So we expect our share repurchases to be at least what they were in 2012 and maybe even slightly exceeded. Our Board has been excellent with the share repurchase program. So we’ll cross that bridge when we come to it, but I don’t have any reason to believe they wouldn’t be supportive of that program. Mark Smith – Feltl & Company: Perfect. Thank you.

Our next question comes from the line of Peter Saleh from Telsey Advisory Group. Your line is open. Peter Saleh – Telsey Advisory Group: Thank you and good morning, gentlemen. It’s actually Ben Perenteon for Peter today. I wanted to just follow up a bit on the last question. In regards to your leverage position, given the recently increased credit facility, can you just talk a little bit about how you’re thinking about leverage given the higher facility and very attractive interest rates today and if that has changed at all in recent times?

Ben, this is John Schnatter. I’ll kind of hit it from just kind of how I see the business. Again, I’ve been doing this for 30 years. This is about as good as I’ve ever seen it. It’s just – it’s really the pizza business is a good business to be in right now, and I just have a lot of confidence in our leadership and our team. We have momentum. We have so much runway in front of us, so my confidence level is a little bit more – is little better or a lot better that it was, say, four years ago. And so, we’re probably going to be a little bit more aggressive with stock buybacks. Lance?

Right. And then to reiterate what I said in my remarks, I’d expect 2013 to look like about – between a range of 1 and 1.4 times EBITDA on our leverage. So you’re seeing us, to John’s point, be a little more aggressive than we used to leverage while still have remaining, what – there leaving what we believe are very conservative level for that in the big scheme of things as we continue to manage the business.

Dan, again, this is John. If we continue to have momentum and success, international, that’s going to be huge. We’re going to continue to have success in U.S. We think that’s going to be huge. And you shrink that stock base and you’ve really got a formula to drive EPS. Peter Saleh – Telsey Advisory Group: Okay. Thank you. And then, also wanted to ask just on the commodity front, can you remind us what your expectations are for cheese prices for the balance of the year, and how much contracting have you done relative to the cheese?

Good question, Dan. This is Lance, I’ll take this one. We don’t give the amounts that we actually have contracted, but what I can share with you is we do have amounts contracted out through the end of the year. What I would quantify as moderate amounts and I’ll leave it at that. Relative to the actual price we expect to see, our full year numbers are in the hard $1.70s. So you can kind of look at the future as for the second half of the year and know that they’re indicating the cheese will likely to be a little bit higher in the second half than it has been in the first half. But our full year numbers from a broad standpoint are in the high dollar 70s. Peter Saleh – Telsey Advisory Group: Okay. Thank you very much, gentlemen.

(Operator Instructions). And our next question comes from the line of Jim Yin from S&P Capital IQ. Your line is open. Jim Yin – S&P Capital IQ: Good morning. Thank you for taking my call. Can you qualify or give some color about the industry in the quarter. Do you see a lot of promotions, and did that have hurt average ticket price in general? And where do see the trend going forward?

This is Tony, Jim. Thanks for your question. From an industry standpoint, I think everybody is aware that the big change are continuing to grow at the expense of the independence and the regional change that’s something that has been taken place consistently and obviously from a size and voice, the brand presence, supply chain, all those factors. But within the industry there is a lot of competitive pricing that continues to take place, value and choice remain paramount. But at Papa John’s, we’re continuing to play on the premium end of that equation and has consistently done that with our pricing and our promotional strategy. The use of LTOs for us has been a great way for us to put our premium brand presence out with the consumer, and we’re going to continue that process.

This is a John Schnatter, just kind of piggy bag on that. It is – the pizza business is a good place to be and frankly we thank our competitors are good of what they do. It is interesting to see all three are about $8 a pizza right now and with us being in the premium brand position, we are able to demand a little bit higher price for our product, because it’s a higher quality product. And the nice thing about that situation is, we do a better pizza and the consumer recognizes that. Also the other fortunate thing is, we don’t operate our business in a vacuum. And whether it’s McDonald’s or Texas Roadhouse or our two leading competitors, if we are feeling the pressure and have to take price soon or later, they are going to feel the same pressure and they are going to have to take price. And we think in that environment all ships arrive.

And Jim, it’s Steve Ritchie. Maybe I will just comment on one of the other certainly key factors within the category and what certainly will find to be an advantage for Papa John’s and that’s digital. As we stated in the last call, well, now over 40% of our sales are coming from the digital side and that’s as a whole. We are seeing significant growth in the mobile side of that piece. And we talked about our corporate restaurants. We have got number of our markets – we don’t get into specifics – we got a number of markets now, over 50% of their sales are coming from digital front. So that’s a key piece for us to be continue to be growing share within the category and alongside I think what you are seeing among the major change in the category. Jim Yin – S&P Capital IQ: Just a follow-up question, I know you’re gaining market share because of the better usage of smartphones and tablet ordering, do you think that trend will continue when some of these smaller regional players to build their own app with iPads and iPhones.

This is Tony. We do believe that they will continue to grow in their usage of digital. Just that’s a nature of the age that we are in, the sophistication though of the larger brands is an advantage, against the smaller chains and I think that gap will remain and continue with the resources that all the big players have to put against that. Last thing I want to comment though on the categories a whole is the pizza category is a great value in the economy that we are in. And there has been in lot of buss out there about the growing, the growth of the pizza categories. So for us it’s Papa John’s. We are certainly growing with that and again in the premium and of that growth. So that would excite us about our premium position. Jim Yin – S&P Capital IQ: Thank you.

And I’m showing no further questions at this time, Mr. Tucker. I would like to turn the conference back to you for closing remarks.

Thank you, Melba. And we’ll wrap the call up. Thanks to everybody for taking a few minutes to join us this morning.

Thank you for participating in today’s conference. Have a wonderful day. You may now disconnect.