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Papa John’s International, Inc. (NASDAQ:PZZA)

Q4 2012 Earnings Conference Call

February 27, 2013 10:00 ET

Executives

John Schnatter - Founder, Chairman and Chief Executive Officer

Lance Tucker - Senior Vice President, Chief Financial Officer, and Treasurer

Tony Thompson - Chief Operating Officer and President, PJ Food Service

Andrew Varga - Chief Marketing Officer

Analysts

Michael Halen - Sidoti & Company

Shawn Bitzan - Feltl and Company

Operator

Good day, ladies and gentlemen and welcome to the Papa John’s Fourth Quarter and Full Year 2012 Conference Call and Webcast. At this time, all participants are in a listen-only mode and later we will conduct a question-and-answer session and instructions will follow at that time. (Operator Instructions) And as a reminder, this call is being recorded.

I would now like to introduce your host for today’s conference, Lance Tucker, SVP, CFO, and Treasurer.

Lance Tucker - Senior Vice President, Chief Financial Officer, and Treasurer

Thank you, Bethany. Good morning. With me on the call today are our Founder, Chairman and CEO, John Schnatter; Chief Operating Officer and President, PJ Food Service, Tony Thompson; Chief Marketing Officer, Andrew Varga, and other members of our management team. After a brief financial update, John will have comments about our business as well Tony, and the management team will then be available for Q&A.

Our discussion today will contain forward-looking statements that involve risks and uncertainties relating to future events. Actual events may differ materially from the projections discussed today. All forward-looking statements should be considered in conjunction with the cautionary statements in our earnings release and 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 the call in the event facts or circumstances subsequently change. In addition, certain financial measures we use on this call are expressed on a non-GAAP basis.

Our GAAP to non-GAAP results reconciliation can be found in our earnings press release available on the Investor Relations section of our website. Unless otherwise noted, all comparisons are versus the same period a year ago. This call is being taped and the replay will be available for a limited time on our website and in downloadable podcast format. Finally, we ask that any media be in a listen-only mode since this is primarily an investor call.

As discussed more fully in the Form 8-K filed yesterday, the company is restating its 2009, 2010, and 2011 financial statements to correct the valuation of the redeemable non-controlling interest related to certain of our joint venture arrangements. This is a non-cash charge that had no impact on revenues, operating income, cash flows, or compliance with the company’s debt covenants. Further, this change in how we measure the value of our minority interest in these joint ventures is not expected to have a meaningful impact on the company’s operating results in future periods.

Our 2012 Form 10-K will be solid on Thursday, February 27 which is tomorrow. Please note that in our operating results discussion on this call, 2011 EPS income tax rate ended income figures we may reference have been restated as described in the 8-K. I would also like to highlight that 2012 was a 53-week year. The numbers we discuss on this call will be our as reported numbers which include the 53rd week. For comparability purposes, the impact of the extra week is shown in a separate table in our earnings press release issued yesterday.

So, now, on to our discussion of operating results. We earned $0.74 per share in the fourth quarter 2012 nearly a 14% increase over $0.65 per share in Q4, 2011. For the full year 2012, earnings per share were $2.58 representing an increase of 19% over $2.16 for the full year 2011. We are very pleased with these 2012 results particular given that we overcame a negative $0.08 impact related to an incentive contribution as we have discussed in prior quarters. Also reflected in our 2012 results, we tentatively agreed to the financial terms of a settlement of the class action litigation Agne versus Papa John’s International, Inc. which is subject to Court approval.

While we will not discuss the financial impact until the agreement has been approved by the Court as we expect included in our G&A line is a reasonable estimate of the total cost of the tentative settlement. We do not expect this matter to have a meaningful impact on 2013 or a future operating results.

Our fourth quarter 2012 revenues increased 20% primarily due to the 53rd week and comparable sales of 5.2% for North America and 7% for international. For the full year 2012, revenues increased 10% primarily due to the 53-week and full year comparable sales of 3.6% for North America and 7.1% for international, excuse me. In addition to the comp sales increases, increased revenues were also driven by the net acquisition of 50 restaurants in the Denver and Minneapolis markets in the second quarter as well as increased volume in our PJ Food Service business and a 7.2% increase in the number of units operating globally on a year-over-year basis.

Our unit openings momentum continues with 134 net units opened worldwide in the fourth quarter. For the year, we opened 280 net units world wide comprised of 143 North America units and 137 international units. On a business segment basis, fourth quarter operating income for domestic company-owned restaurants increased approximately $4.5 million. This increase was primarily due to increased comparable sales of 6.9% in the 53rd week partially offset by higher commodity costs. For the full year 2012 domestic company-owned restaurant operating income increased approximately $9.1 million primarily due to increased comparable sales of 5.6%, the 53rd week and favorable commodity costs.

Operating income for our domestic commissary business segment decreased $1.1 million for the fourth quarter due to lower margins resulting from lower prices charged to restaurants, partially offset by the positive impact of the 53rd week. For the full year 2012 operating income for the domestic commissary business increased $3.8 million due to increases in net restaurants and restaurant sales as well as the 53rd week.

Fourth quarter operating income for our North America franchising segment increased approximately $2.5 million due to the increase in net units, 4.6% comp sales and the 53rd week. For the year operating income increased to $3.1 million primarily due to the comparable sales increases of 2.9%, increases in the number of franchise units and the 53rd week.

Operating results for our international segment improved approximately $1.2 million for the fourth quarter due to increases in net units, comp sales of 7% and the 53rd week. For the full year operating income for the international segment increased $3.2 million for the same reasons. We are especially pleased with these international results as the continued execution of our strategy allowed us to obtain profitability for the first time in many years in our international business segment. And note, these results include full year profitability for our UK business, a significant milestone as we continued to grow the Papa John’s brand globally.

For the fourth quarter, our unallocated corporate expenses much of which are included in the G&A line of our financials increased approximately $5.2 million due primarily to the tentative settlement costs already discussed and higher short-term management incentives which were driven by the company’s very strong 2012 operating results. For the full year unallocated corporate expenses increased $9.2 million for the same reasons plus the incentive contribution costs of $4 million discussed in the previous quarters and recorded in this segment.

Our effective tax rates were 30.7% and 32.9% for the three and 12 months ended December 30, 2012, increases of 2.1% and 1.9% versus the prior year periods. Our effective rate may fluctuate for various reasons including settlement or resolution of specific federal and state issues. And I should point out that 2011 included significant favorable tax resolution items.

We have repurchased approximately $42 million of stock during the fourth quarter bringing year-to-date share repurchases to approximately $106 million for 2012. Following approval by our Board of Directors of an additional $50 million in both December and February that maybe purchased under the company’s share repurchase program, the company had $115 million of remaining share repurchase authorization as of February 24.

Our free cash flow, a non-GAAP measure we define as cash flow from operations or less capital expenditures was $61.8 million in 2012. Our net debt provision defined as total debt, less cash, and cash equivalents was $71.9 million at year end. The company also announced its 2013 key operating assumptions and earnings guidance.

I’ll quickly go through the key amounts as follows. EPS of $2.85 to $2.95 or a 10% to 14% increase over 2012 53-week results; North America system-wide comparable sales increases of 1.5% to 2.5%; international comparable sales on a constant dollar basis of 5% to 7%; consolidated revenue growth of 6% to 7% over 2012 53-week results. Worldwide net unit growth of 230 to 260 units including 110 to 125 units in North America and 120 to 135 units in international markets. Pre-tax margin is expected to approximate 2012 levels.

And finally, capital expenditures of $55 million to $60 million driven by continued company-owned unit development in North China and certain technology-related projects including cost associated with our next generation point-of-sale systems.

And now, I’d like to turn the call over to our Founder, Chairman, and CEO, John Schnatter. John?

John Schnatter - Founder, Chairman and Chief Executive Officer

Hey, thanks Lance and good morning. We appreciate each of you taking the time to be with us today on the call to discuss our fourth quarter and full year 2012 results. As always, I’d like to start out by congratulating our franchisees and our operators throughout the world for a very good fourth quarter and an outstanding full year 2012. I know I have sounded like a broken record the last two or three years, but our business is extremely solid on just about every single front. And our global system has excelled in delivering on our better ingredients, better pizza promise throughout the world. And our fourth quarter and full year results certain bear that out.

Now, Lance covered a lot of ground in his opening remarks, but what is really all boils down to is it this management team has achieved compounded annual growth and EPS of 19% over the past two years with two-year North America comp sales of 7% in 517 net global restaurant openings over the same two-year timeframe. In short, we built a lot of momentum over the past few years and that has positioned Papa John’s for a very bright future.

Specifically, in 2012, as Lance noted, our North America operators posted a 5.2% positive comp sales during the quarter and 3.6% positive comps full year of 2012 marking the 9th consecutive year of positive or flat North America comp sales growth. Our international operators also posted a very robust 7% positive comp sales growth during the quarter and 7.1% positive comps for all of 2012. Given the global climate, we are operating in during the quarter and the year, I am obviously very impressed with these results.

I was also very pleased with our restaurant growth numbers during the quarter and the year. Our system achieved a 134 net worldwide restaurant openings during the fourth quarter and 280 net openings for the full year. This represents the highest number of global net restaurant openings in more than 10 years and we certainly expect this continued growth to keep happening. Today, we are approaching 4200 restaurants globally with a strong global development pipeline with agreements in place to open approximately 1400 restaurants over the next six years. I am very excited about the future of our brand worldwide.

We have been able to grow our global footprint due to large parts and the solid progress we are seeing in our international operations. In addition to strong comp sales during the quarter full year, as Lance mentioned, our international business was profitable in 2012. This is the significant on many levels including the validation that our international business model is improving and then our brand is resonating with the consumers worldwide.

Now, on the development front, international opened 86 net new restaurants for the quarter and a 137 net for 2012. And while I am very pleased with these international development numbers, I am even more excited by the fact that we are partnering with franchisees around the world that are more committed to the brand and our brand promise than any point in our company’s history.

Finally, I’d like to spend a moment commenting on our marketing and branding. In 2012, we completed third year of our three-year sponsorship with the NFL. We have been so pleased with this partnership that we extended the partnership for the long-term. We also welcome Peyton Manning to the Papa John’s team, first as a spokesperson for the brand and then as a franchisee, partnering in 22 restaurants in the Denver market. We are confident that our NFL relationship will continue to pay dividends for the brand for years to come. And it serves that the model for us as we look to replicate the success with future partnerships around the world.

And with that, I’ll turn it over to Tony Thompson. Tony?

Tony Thompson - Chief Operating Officer and President, PJ Food Service

Thanks John. I would like to echo John’s comments and congratulate our system on a very solid quarter and year. By investing in our franchisees and operations, we were able to capture market share in 2012, while growing our global footprint and celebrating several milestone openings during the quarter and year including the opening of our 4,000th restaurant in our global system, the 200th restaurant in the United Kingdom and the first Papa John’s restaurants Azerbaijan, Lebanon and Guam.

With 2013 worldwide net restaurant growth expected to be in the 230 to 260 range. I am really excited about long-term global prospects of the Papa John’s brand. We also continued to make significant investments in the technology and infrastructure of our system, designed to help our restaurants operate at peak performance and support the tremendous growth opportunity in front of us. We are making a major investment in a significantly updated POS system that when fully deployed will support continued store level productivity and profitability.

We are also are investing in a state-of-the-art dough production facility that will open mid-year at our current distribution location in New Jersey. Once operational, this quality control center will supply our fresh dough and other high quality ingredients for our restaurants in the Northeast, while positioning the brand to support our continued growth in that region of the U.S.

Finally, I would like to comment briefly on our franchise relations, which are healthier today than at anytime since I had been with the company over the past six years. The spirit of team work and collaboration with our franchise advisory council has served to help move the system forward and has highlighted the collective commitment to the Papa John’s brand that we all share. That commitment has resulted in a win, win, win proposition.

Most importantly, our customers went with the better quality pizza. And we along with our franchisees win by being profitable. In 2012, our brand also won by earning two prestigious industry awards. Papa John’s won brand of the year honors in the pizza category of the 2012 Harris Poll EquiTrend study. And for the 11th time in 13 years, Papa John’s was rated tops in customer satisfaction among limited service restaurants in the 2012 American Customer Satisfaction Index. This validation of our continued focus on quality and the customer is both humbling and motivating and we will continue to strive to perform even better in 2013.

With that, I want to turn it back over to Lance for questions.

Lance Tucker - Senior Vice President, Chief Financial Officer and Treasurer

Definitely I believe we are ready for questions please.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of Michael Halen with Sidoti & Company. Your line is open.

Michael Halen - Sidoti & Company

Thank you. Good morning.

John Schnatter

Hi, Mike.

Michael Halen - Sidoti & Company

My questions I guess let’s start with the guidance for a flat pre-tax margins next year. Can you just talk about I was a little bit surprising in light of the 20% decline in cheese costs since October. So, can you talk a little bit about what’s going on there and what impact maybe discounting or hedges are going to have on that margin?

John Schnatter

Mike I will talk in general terms about the guidance on the margin. First of all as to address your question related to the commodity prices, we do expect commodity prices to be up a little bit in 2013 over what we’ve seen in 2012. I will let Andrew and or Tony or Steve talk to the competitive environment. But it is competitive environment. There is going to be some gives and some takes relative to the margins both on the cost on the revenue side I expect and so we decided, we think we are going to look pretty consistent with what we have seen this year.

Lance Tucker

Yeah, I go ahead and tackle the pricing side. We as you know in past calls have talked to you all about the fact that we really believe we can maintain a premium against the competitive set and we see that continuing in 2013. The key piece of that is what exactly is that price point where the premium is going to reside? And so, we are watching that closely. We continue to price our products above our key competitors and we’ll continue to move in that activity. But so far, we are just really taking a look at where our pricing is and obviously it all comes down to what the consumers willing to pay and we tend to believe we’ve done a very good job of making sure then we’re extracting full value from the consumer regardless of the economic or category environment.

Tony Thompson

This is Tony. And although cheese prices are currently little bit lower than what we’ve seen, they are expected to increase, futures are by the end of the year. So, I want to definitely factor that in. And the other thing is we are seeing a cautious consumer right now from the beginning of the year the tax holiday expiration, fuel prices, the delay in income tax returns, all those factors are certainly playing into consumer confidence along with what Andrew talked about within the pricing environment value and choice are going to be a – its going to remain for sometime. But the pizza category not only is resilient, it is certainly a great value in an environment like this. And we believe from a quality position that is going to continue to serve us well in this pricing category where people are going to choose. They are going to make the choice for something its better. So,, we are feeling really good about that.

John Schnatter

Michael, this is John Schnatter to add little bit more depth on the cheese question. We do hedge cheese corporately, but we don’t with our franchisees. Corporate’s mindset is a little bit more let’s cover the downside just in case cheese does go way up. And we feel like the upside will take care of itself. Our franchisees have more of a tendency to want to roll the dice and just hope price goes down. And there was a period earlier in 2012 where we actually paid a little more for cheese than our franchisees and frankly that didn’t bother us. We found that if we get off the first part of the year off to a good start which we had this year. And we’ve got our cheese hedged and fuel doesn’t do anything crazy, then we can have a pretty solid year.

Michael Halen - Sidoti & Company

Thank you very much gentlemen.

Operator

(Operator Instructions) Our next question comes from the line of Mark Smith with Feltl and Company. Your line is open.

Shawn Bitzan - Feltl and Company

Hi guys this is Shawn Bitzan sitting in for Mark Smith. Has the mix of online sales changed at all?

John Schnatter

I’ll go ahead and take that obviously we continued to improve our online sales mix. I think we’ve talked to you all in the past that we have been north of 40%. And we continue to believe that online is just critical, not only for the customer experience, but just in general for being able to drive more top line sales. So, we love the progress we are making there.

Shawn Bitzan - Feltl and Company

Any global markets that are significantly under or over performing that we should be keeping an eye on?

Lance Tucker

Shawn this is Lance. I’m going to start with that and we really don’t speak much specifically to our international markets on a country-by-country basis. We do occasionally give a little bit of information about the UK, but that’s the only one, so for now we’re going to let Tony jump in on that as well.

Tony Thompson

And the only thing I would add is as our guidance implies for 2013 I think you see that we’re continuing to be confident in our business model I mean in international. So, we’re going to continue to see strong ramp up in both sales and profitability.

Shawn Bitzan - Feltl and Company

And last one your net unit gross guidance is below what you just drew in 2012, is that just being conservative or is the unit growth actually slowing. And how do you feel about your pipeline?

John Schnatter

I’ll start with that. We feel very strong about our pipeline, we still have 1400 units give or take over the next six years in our pipeline. So, there is no slowing as Tony referenced earlier. However, you do see some things going on in the economy at large not only here in the U.S. but internationally. We’re just taking a little bit of cautious view for now to make sure that we put guidance out there that is realistic and we will address that as we go throughout the year.

Tony Thompson

This is Tony, we do feel that our projections and our guidance is A, it’s consistent and it’s certainly a strong growth for us in 2013. And we have got the utmost confidence in all of our markets as a matter of fact this afternoon our – many of our senior team are going on an international trip to our key markets overseas. And we do that usually twice a year where we go out and meet with the franchisees, listen to them and engage in those markets. So, I’ll turn it over to John?

John Schnatter

Shawn, this is John Schnatter. The – I can tell you the business and the company as a whole is in more of proactive position than anytime I can remember and that also applies to development. As far as our earnings remember 2012 our original earnings guidance was $2.33 to $2.43 and then May 8, we upped that $2.40 to $2.50 EPS and then August 1st we upped that again to $2.45 to $2.55 and then October 31st we upped it again to $2.53 to $2.63. And we came in at $2.58 and that was with a lot of non-recurring items. So, hopefully in 2013, we can repeat that track record.

Shawn Bitzan - Feltl and Company

Thanks guys. That’s all I have.

Operator

(Operator Instructions) We have a question from the line of Bruce Keller with (indiscernible). Your line is open.

Unidentified Analyst

Hi, good morning. Its (indiscernible) is the firm. Can you please quantify what the legal settlement cost you in the quarter?

Lance Tucker

Because this is still a tentative settlement that has not yet been approved by the court, we cannot quantify at this time. Once everything has been approved and we only expect that we’ll be able to talk more openly about those amounts.

Unidentified Analyst

Okay. And does your earnings guidance include anything for share repurchases or would that be considered incremental as you purchase shares throughout the year?

Lance Tucker

We do anticipate similar numbers to what we’ve seen in 2013 and 2012 that’s our current expectation. I would also reiterate back on the settlement question, we do believe that we have a very reasonable estimate on our current financials in 2012 for that. So, I wouldn’t expect any more material impact from that legal settlement.

John Schnatter

And Bruce, this is John Schnatter. One thing I want to note is we do – we jut stepped up our authorization to $115 million. So, when the stock does extremely well that’s good for everybody and if it does have a buying opportunity, then we have that’s where we have such a healthy balance sheet as we have the flexibility to take full advantage if the stock goes down and as you know about we bought $42 million last quarter, so we believe in what we’re doing here.

Unidentified Analyst

Sure, no that’s great. I appreciate that. And my last question you mentioned that you extended your partnership with the NFL. Can you give a little bit more color on that for how long and I don’t know if you have ever disclosed how much that costs you on in annual basis, but I’ll just would be curious if you get a little bit more color on the extension of that partnership which seems to have worked out very well for you.

Andrew Varga

Hi, Bruce, this is Andrew. I will go ahead and take that. All I can tell you on the extension is that it is long-term extension we don’t give out the length of that extension. But suffice to say John hit on his comments, we have just been thrilled with the first three years of our partnership with the NFL, it gives us such a fantastic brand building platform with some of the most intense pizza consumers in the United States and in some cases around the world. Adding Peyton Manning into the mix with our founder just provides, just enormous authenticity for the brand as we go to communicate the brand using this platform. And we are just excited and delighted that we’re going to able to continue that for years to come. So, I appreciate the question and hope that’s helpful.

Unidentified Analyst

Great. Thanks and congratulations on a terrific year.

Lance Tucker

Thank you.

Operator

At this time, I’m showing no other questions. I would like to turn it back to management for any closing remarks.

Lance Tucker - Senior Vice President, Chief Financial Officer, and Treasurer

Thank you, Bethany and thank you to everybody for being on call. Have a good day.

John Schnatter - Founder, Chairman and Chief Executive Officer

Thank you.

Operator

Ladies and gentlemen, this does conclude your conference. You all may disconnect and have a good day.

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