Papa John's International Inc. Q4 2008 Earnings Call Transcript

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 |  About: Papa John's International, Inc. (PZZA)
by: SA Transcripts

Operator

Welcome to the Papa John’s fourth quarter earnings conference call. (Operator Instructions) Mr. Flanery, you may begin your conference.

J. David Flanery

With me on the call today are our Founder, Chairman and Interim CEO John Schnatter; President USA Bill Van Epps; Senior Vice President of U.S. Operations Bill Mitchell; President PJ Food Service and Preferred Marketing Solutions Julie Larner; and other members of our executive 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. Certain factors that can cause actual results to materially differ are outlined in our earnings release and in our Forms 10-Q and 10-K. The call is being taped and the replay will be available for a limited time on our website and in downloadable podcast format.

A lot has happened since we reported third quarter results in early November. Although the overall economic picture has shown no real improvement, we did see sales stabilize in November and December following a very difficult start to the quarter in October, as previously noted.

We’re also pleased that these more stable sales results have continued into 2009. However, given that we believe that unemployment is a strong leading indicator of future sales trends and there is no firm consensus on what impact the stimulus package may have on consumers and the economy as a whole, we continue to have questions regarding sales visibility throughout the rest of the year.

The good news is that commodities have moderated especially cheese, which I’ll have more to say about later. Of course, the primary reason for the softening of commodity prices is the expectation of reduced demand so everything really does revolve around the consumer. One other piece of relatively good news is that the restaurant category has historically been on the leading edge of an economic recovery once employment trends stabilize.

And, of course, we have our Founder, John Schnatter, back in a day-to-day leadership role if only for an interim period. It is appropriate that John’s return as Interim CEO coincides with the year long celebration of our 25th anniversary. Better ingredients still make a better pizza after all these years and who better to drive that message home than Papa John himself.

Our fourth quarter and full year results for 2008 were very solid given the economic environment. Earnings per share adjusted for certain noted items were $0.48 for the quarter and $1.68 for the year. Although the $1.68 was $0.02 lower than the prior year comparable result, it was in line with the low end of our initial earnings guidance range for the year and not many restaurant companies were able to achieve originally projected results for the year.

We were also pleased with posting nine-tenths of a percent positive comparable sales results for the year, 1.7% positive at company owned units, and six-tenths percent positive at franchise units and achieving 32 net unit openings domestically. We outpaced our two major national competitors in both important categories.

Pre-tax income, excluding the noted items, was $1.7 million lower during the quarter and $3.4 million lower for the year as compared to the same periods of the prior year. On a business unit basis, company owned restaurants were relatively flat on a year-over-year basis for both the quarter and the year. The domestic commissary business unit was relatively flat for the quarter and $5.6 million lower for the year due to absorbing commodity and fuel cost increases during the year.

Domestic franchising operating income was $1.3 million lower for the quarter and $2.1 million higher for the full year. The results of the quarter reflect the franchise renewal fees collected in the prior year, the impact of which was more than offset on a full year basis by the quarter point increase in the royalty rate to 4.25%.

The international business unit operating loss was $2 million lower for the quarter and $3.8 million lower for the full year as compared to the same periods of 2007 due to continued leveraging of the infrastructure as a result of unit and unit volume growth. There were 140 net unit openings during the year in the international business unit and international franchise sales increased 25.5% for the year.

Unallocated corporate expenses were $3 million higher for the quarter and $4.7 million higher for the year as year-over-year reductions in administrative costs, including travel and benefits expenses and cash and equity compensation, were more than offset by the incremental system marketing support and increased accounts in notes receivable reserves in the fourth quarter.

The total $8.8 million in closure, impairment and disposition charges for the year includes $3.3 million related to the re-franchising of 62 domestic restaurants and $2.3 million of impairment charges related to the PJ U.K. operations, primarily as a result of the strengthening of the dollar relative to the pound during the year.

Our free cash flow, a non-GAAP measure we define as net income, excluding BIBP, plus depreciation and amortization expense less capital expenditure was $47.2 million for the year representing a free cash flow yield of 8.4% based upon $28.3 million average diluted shares outstanding and yesterdays closing market price of $19.88.

We slowed our share repurchase activity during the fourth quarter due to general economic and financial market conditions, but resumed it in January pursuant to a Rule 10b5-1 trading plan. We repurchased 1.4 million shares during 2008 for a total of $37.7 million and have current remaining repurchase authorization of approximately $57 million.

We are increasing our 2009 earnings guidance by $0.04 to a range of $1.36 to $1.44 as a result of the expected impact of the recent substantial reductions in the spot and futures market prices for cheese. As noted in our initial December release, this guidance includes $0.30 to $0.35 per share unfavorable impact of 2009 initiatives most notably related to a range of franchise support activities.

In response to the reductions in cheese prices, we have modified the BIBP processing formula effective in period three to a monthly sliding scale premium over the futures market projections for the period. We expect that this modified formula will result in an approximate five-tenths of a percent reduction in food cost at the restaurant level from the pervious guidance, while still generating an estimated $20 million plus reduction in the BIBP deficit.

We further expect that this modified formula will lead to the substantial repayment of the BIBP deficit by the end of 2011.

Now I’d like to turn the call over to our Founder and Interim CEO, John Schnatter.

John Schnatter

First, I’d like to thank Nigel Travis for his years of service. Nigel did a lot of good things at Papa John’s and we wish him the best at Duncan Brands. I know I speak for the board and the entire Papa John’s family that we wish him the best in his new role and all his future endeavors.

Also, I’m honored and thankful for the board of directors to serve on an interim basis as CEO as we search for a new CEO. I also want to thank a board member, Jude Thompson, who has assisted me during this transition process. His service has been invaluable and has really helped the business get in a proactive position versus a reactive position.

The search process is going extremely well and hopefully we’ll have a new CEO in position by our shareholder meeting April 30th. I can tell you the last 80 days had been invigorating and, as I’ve been back in the day-to-day business, things are going exceptionally well. I visited several domestic markets and seven international markets and I got to tell you I like what I’m seeing.

We had tremendous momentum on the international area. International is in such better shape today than it was even two or three years ago. We just celebrated our 600th international opening. And let’s put that in prospective. It took us ten years to open 500 and it took us only seven months to open our next 100. We now have over 200 restaurants in Asia, well over 100 restaurants in each Europe and Latin America and we’re quickly approaching 100 restaurants in the Middle East.

I just was over in Kuwait, Iran and Egypt and our Bahrainian franchisee and Kuwait franchisees are exceptional. We are a market leader in Iran, which is the first international market that we are actually number one in so we’re extremely excited about that.

The investments we had made in building our international team and infrastructure are definitely paying off and I’m excited to see the founder of better ingredients better pizza throughout the world. As you’ve heard me say on many occasions, I believe the key to Papa John’s success is our people and hour high quality product, our pizzas and our high service levels.

We continue to win customers on the frontline with outstanding teams in our franchise and company owned restaurants. Bill Mitchell has done an exceptional job with our company stores and we’re excited about the momentum and the start we have in 2009 with our corporate restaurants, as well as our franchise restaurants.

And I can tell you as we celebrate our 25th anniversary, I’m proud to say that the commitment we have today is as strong as it was 25 years ago in the back of the bar in the broom closet. Certainly these are challenging times for the pizza category.

Last year our system managed through the triple whammy of increasing commodities, minimum wage and fuel cost. Thankfully the cost of commodities, cheese in particular, and fuel have moderated over the last 90 days giving our restaurant operators some relief in these two areas. And so we’re back to a healthy store level unit economics FLM.

To further support our stores, our job at corporate is to drive cost out and drive sales up to ensure our franchise partners and our corporate operators alike have a viable business model to withstand these challenges. And I can assure you we attack this on a day to day basis. We think supporting our franchisees through our relief program is the right thing to do. We will continue to do that as we position Papa John’s to take market share in a consolidated pizza category.

It’s been an honor to serve our shareholders this last 80 days. We will continue to work hard and at this time I’ll turn it over to Dave Flanery for questions. David?

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Brad Ludington – KeyBanc Capital.

Brad Ludington – KeyBanc Capital Markets

Congratulations on the quarter. It’s good to see some good news in this environment. I had a couple of questions, well starting off with the diluted share cap, there was no dilution here in the fourth quarter, is that correct?

J. David Flanery

Yes. That’s pretty much correct.

Brad Ludington – KeyBanc Capital Markets

And then looking at your previous guidance, do you still expect international sales to grow by 25% to 30% given the stronger dollar at this point?

J. David Flanery

Yes, we’re still pretty comfortable. Most of our international growth at this point is focused on new unit development and we feel good about that at this point.

Brad Ludington – KeyBanc Capital Markets

And on share repurchases, is there a goal to complete a certain portion of the $57.5 million that remains or is it just going to kind of opportunistic?

J. David Flanery

I think you’ll see us be very conservative as we were in fourth quarter. It’s nice to have the availability there, but I think we’ll be pretty prudent on how we do that in 2009.

John H. Schnatter

Yes. We have two dichotomies going on, this is John. The first is the momentum of the business is extremely good right now, so you have a tendency to get aggressive. With that being said, this economic outlook is questionable. So we’re trying to balance the real world of what’s going on out in the market with the success that we’re having here at Papa John’s. So we will be conservative, but we will be opportunistic at the same time.

Brad Ludington – KeyBanc Capital Markets

Last question, what should we expect CapEx to be in ’09?

J. David Flanery

Our formal guidance is in that $30 to $35 million range. We’ve done a nice job the past several years of coming in below our formal guidance, but at this point we’re going to leave our formal guidance as is. But know that we watch things very carefully on our capital spending.

Operator

Your next question comes from Michael Wolleben – Sidoti & Company.

Michael Wolleben – Sidoti & Company, LLC

I was wondering if you guys could comment here on what your franchisees domestically are feeling in forms of stress from the consumer on the slower sales volume and how your initiatives are relieving some of that stress for them.

John H. Schnatter

I think franchisees are excited right now. Where we were four months ago on the commodity market is night and day. We feel like our food, labor, mileage numbers this coming week will probably be an all time low, which our business is, if food, labor, mileage are low and sales are up, they’re happy. If food, labor and mileage are high and sales are down they’re unhappy. And so we have kind of a combination of both the good attributes going on.

They’ve been extremely gracious to me the last three months with my return. The system is excited. I’ll let Bill Mitchell jump in here, but the system is excited and invigorated is probably the best way to describe Papa John’s right now, as far as franchisees.

William M. Mitchell

Yes John, and we see a lot of excitement in the field and it’s on two things. One, we believe we’ve got the best people in the business. We believe we have the best product in the business and, as John mentioned, with favorable commodities, it’s giving us an additional weapon to take that to the street. And so as we look at our markets across the country, we see lots of wins for the quarter and lots of wins as we move forward.

Michael Wolleben – Sidoti & Company, LLC

We only saw 17 closures here domestically in the fourth quarter. Is that a function of these sales picking back up? Is that a function of your support initiatives? Is that a function of operators seeing better margins from these commodity price decreases?

John H. Schnatter

I think the answer is yes to all of the above.

Michael Wolleben – Sidoti & Company, LLC

And then two other quick things here, on the international side, as you guys are getting closer to breaking even, any thoughts on giving a comp number?

J. David Flanery

It’s still all about unit development and we have so many markets that are really still in that heavy ramp up stage. We will continue to think about that and clearly at some point, we will do that. But I’m not sure if it’s the next couple of years or it may be a little longer term than that.

John H. Schnatter

As far as the international front goes, four years ago I didn’t understand, of course building a company out of a bar in Jeffersonville, I didn’t understand how international was going to work and I didn’t see it. I’ve been in China four times in three years and we’re doing a lot of international travel. I now see a vision on how Papa John’s is going to be a successful international company. I can see it. And Dave and his team with Miles and Ian are doing a fantastic job executing that vision and I think we can get that done.

Michael Wolleben – Sidoti & Company, LLC

And lastly, you commented that you were hoping to have a CEO here by April 30th. Can you kind of just give any idea, any color on what experiences you’re looking for. Are you looking for somebody with international experience, franchise experience, kind of what you’re looking for?

John H. Schnatter

I think the characteristics and the competencies are crucial, but probably not as critical as fitting in with the Papa John’s culture. Our company is a different kind of place. We’re not a normal company. We don’t want to be a normal kind of company and we function differently. We function as a team. The people at the bottom are just as important as the people at the top.

We do have a collaborative alliance with our franchisees, with our suppliers, with each other, with our shareholders, and the place is just a different kind of place. I think the fit is as much cultural as it is competence. I don’t know if that answers your question, but I’m looking more for attitude than I am for aptitude.

I can teach somebody the pizza business, but the behavioral and interpersonal relationships I think are more critical than the aptitude aspect.

Operator

Your next question comes from Mark Smith – Feltl and Company.

Mark Smith – Feltl and Company

First off looking at the G&A, a pretty significant sequential and year-over-year decline in G&A spending, and obviously there’s some benefit from Nigel’s departure and looking at that, but what should we be looking at kind of a run rate going forward in ’09?

J. David Flanery

I’ll start with that, Mark. Certainly as we saw fourth quarter starting out, where commodities hadn’t yet broken and where sales were soft in October, we really tightened the screws down pretty well in a lot of G&A areas. We watched travel. We watched any kind of new or even replacement positions from a headcount point of view.

And then as you pointed out, we did get some benefits from, not only the unvested equity of some of the folks most notably Nigel who left, but we also had other compensation programs where ultimate payouts were less at the end of the year because of not hitting certain targets. So I think fourth quarter had perhaps some unusually positive things happen that wouldn’t necessarily flow into ’09.

Now I can tell you, we are going to take just as hard a look at ’09 G&A and make sure we’ve got our overhead structure and our management structure fitting the business and the environment we’re in, but I don’t think you’ll be able to see a fourth quarter run rate because of all those one offs. Somewhere between kind of maybe where we were third and fourth quarters would be more of a normal run rate going forward, I think.

Mark Smith – Feltl and Company

Second, with cheese prices down as low as they are here and you’re re-pricing on the BIBP, can you talk about any potential to possible reduce some of the other incentives to the franchisees and if we’re still too early to talk about a possible royalty rate bump up in the middle of the year.

John H. Schnatter

I’ll let Jude jump in here because he actually sits on the board also. The initiatives are authorized by the board every quarter because the numbers are so big and to your point, we have a different picture of reality today in February than we did in November when the board made the decision to support the franchise system.

We don’t want to get over aggressive with not supporting the franchisees because times are good because you don’t know in this environment when they’ll turn south. But it is something that the board will have directive over every quarter.

Jude Thompson

This is Jude Thompson. I’ll make a few comments about that. Being in here with John and this management team over the last couple of months, it’s something you measure every day that you monitor every day. We have a very close relationship, obviously with our franchises system, and we take a look at the ones that we need to make sure that we’re giving the right support to.

I would say there’s good momentum John, David both have mentioned that as we ended the fourth quarter, and as we go in to P1 and P2 we did get a break on commodities and I think we’re trying to take a look at the dollars that we set aside as support and make sure they get to the right people at the right time. It’s important that our system gets stronger during this time period, and that’s the way we view it here at Papa John’s is that this is a time for us to get stronger.

Mark Smith – Feltl and Company

Last question, can you just give me your overall view on discounting in this environment, especially with cheese prices going lower. I guess the fear would be that if you’re competitors continue to lower their prices and everybody starts really competing on price and value offerings possibly any margin declines there, if you can just give us your overall views on that.

John H. Schnatter

This is John. I’ll comment macro and let Bill Van Epps and Bill Mitchell comment on what they’re seeing now. We have not chased our competitors down the price rat hole, as they call it. We don’t think anybody can own price long-term, especially when you have a differentiating position as we do of better ingredients better piazza.

The platform by which we operate our business on quality is a tremendous asset. Granted this is a game of jockeys. You have to have good management but at the end of the day the best horse wins and we have the best horse with Papa John’s. We are in the best position. Marketing wise our model we think is tremendous, our technology platform, and so at the end of the day it’s all about riding the best horse and we have the best horse and so we need to capitalize on that best horse platform. Bill?

William M. Van Epps

Mark, I’d like to add a couple of comments. If you recall in the pizza category a lot of our competitors have been selling $5 pizzas and we’ve never had to do that because we execute based on information that we get from our consumers at a pretty high level in terms of customer satisfaction, delivery time, quality of product.

So we don’t have to discount quite as much as our competitors and our objective, obviously, is to steal market share where we can. That said, the environment has changed and we are adding more value to our offers, and with the commodities price decrease, you’ll see more value from us in the future as compared to the recent past. Bill?

William M. Mitchell

And I would just add that our quality positioning gives us added flexibility and we see that in multiple markets across the country. It allows our both company and franchise operators flexibility in both pricing, and when we deliver a piping hot Papa John’s pizza to your door in 34 minutes or less, it is a value versus our competition.

Operator

There are no further questions at this time.

John H. Schnatter

Thanks everyone.

Operator

This does conclude today’s conference call. You may now disconnect.

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