Papa John’s International, Inc. (NASDAQ:PZZA) Q1 2023 Earnings Call Transcript

Papa John’s International, Inc. (NASDAQ:PZZA) Q1 2023 Earnings Call Transcript May 4, 2023

Operator: Good day and thank you for standing by. Welcome to the Papa John’s First Quarter 2023 Conference Call and Webcast. After the speakers’ presentation there will be a question-and-answer session. Be advised that today’s conference is being recorded. I would now like to hand the conference over to Stacy Frole, Vice President of Investor Relations. Please go ahead.

Stacy Frole: Good morning, and welcome to our first quarter earnings conference call. This morning, we issued our 2023 first quarter earnings release. A copy of the release can be obtained on our Investor Relations website at ir.papajohns.com under the News Releases tab or by contacting our Investor Relations department at investor_relations@papajohns.com. On the call this morning are Rob Lynch, our President and CEO and Chris Collins, our Interim Principal Financial and Accounting Officer. Before we begin, I need to remind you that comments made during this call will include forward-looking statement within the meaning of the federal securities laws. These statements may involve risks and uncertainties that could cause actual results to differ materially from these statements.

Forward-looking statement should be considered in conjunction with the cautionary statements in our earnings release, and the risk factors included in our SEC filings. In addition, please refer to our earnings release for the required reconciliation of non-GAAP financial measures discussed on today’s call. Lastly, let me thank you in advance for asking only one question and getting back in the queue for more follow up. Rob?

Rob Lynch: Thank you, Stacy. Good morning, everyone, and thanks for joining us. Overall, we are pleased with our first quarter performance, which was consistent with our expectations and resulted in the highest global system-wide sales and company history. Our North America comparable sales were in line with our record results we achieved a year ago and supported by 3% growth in our domestic company-owned restaurants. In the first quarter, we also opened 59 new restaurants. We are extremely proud of our accomplishments over the last three and a half year. We’ve built a unique infrastructure and business model that is designed for sustainable sales growth. We’ve built an amazing product pipeline with new platforms that keep producing new ideas.

We have also significantly improved our operations to support our business moving forward, and we have built a company culture that makes us all proud. But we know there is more to be done, and we have yet to realize our full potential. We continue to see opportunities to get better and create value for our customers, our franchisees and our shareholders. This is why I’m so excited about the future of Papa John’s, the challenges and opportunities that we have to get better.

fees: Our track record of delivering three straight years positive comp sales gives us confidence that we can deliver on our long term targets. Over the past several years, we have been investing in technology and building an organizational infrastructure necessary to operate an industry leading CRM platform that is designed to drive brand engagement through relational and set of transactional experiences. Today, approximately 85% of our sales come through digital channels and we have nearly 30 million loyalty member accounts. We have a significant data platform that we must utilize to enhance our brand and make the digital experience for our customers better by offering personalization that drives activation. Our focus continues to be on care of our customers and driving top line growth.

I’m happy to say that we announced this week that Mark Shambura will be joining Papa John as our new Chief Marketing Officer. I’m confident that it’s more than two decades of experience in growing restaurant brands, including most recently at MOD Pizza and Chipotle, will help to drive continued engagement and growth among all consumer segments. Our recent investments in digital innovation will only get better with Mark’s digital first analytics led approach. We look forward to igniting our brand engagement strategy under Mark’s leadership. As I’ve already stated, we have continued to evolve our menu innovation strategy as we build strong brand partnerships to raise awareness and attract new customers. At the end of December, we launched our new Papa Bites platform, which includes small bite sized snacks and old new flavors utilizing our fresh dough.

Our Oreo Papa bites were especially well received by our customers and were highly incremental to our dessert category, helping drive higher ticket throughout the quarter. We also launched our Crispy Parm Pizza in February, making us the first large pizza chain to launch a thin crust pizza with cheese on all sides of the crust. Looking forward, we’re excited about our new collaboration with Pepsi and Frito Lay that inspired our newest proprietary menu offering, Doritos, Cool Ranch, Papadia. This new offering is covered with bold ranch seasoning and includes Doritos, Cool Ranch dipping sauce only available at Papa John’s. We’re thrilled to roll it out nationwide beginning today. We expect this premium innovation will drive both transaction and ticket growth as we target current and new customers.

With this launch, we are strategically targeting a younger demographic at loyal Doritos consumers. And with a price point of $7.99, it’s a great value. As we previously discussed, our barbell strategy focuses on reducing both premium and core value menu items. On the value side, we continue to see strength in our Papa pairings offering, which provides consumers with an array of great product and an attractive $6.99 price point. In the first quarter, we added our new hot lemon pepper chicken wings to our Papa Pairings platform. Papa Pairings will continue to be a platform where we can bring side item innovation to market. Great operations is at the heart of everything we do. Our Back to BETTER operations initiative launched in the fourth quarter last year across our corporate restaurants is helping to further improve execution at the store level while enhancing customer service.

These efforts are helping to mitigate inflationary pressures today, and over the longer term will deliver improved unit economics across our system. Our back to better initiatives aligns our organization on KPIs that provide the best experience for our team members and our customers harnessing what our brand was built upon, a relentless pursuit of better. Our data insights help us drive improved performance in key areas like out-the-door times. For the first quarter, our out-the-door times and corporate restaurants have improved by more than 25% on a year-over-year basis. Faster delivery ensures that our products are hot when they arrive. Food temperature is the number one driver of product satisfaction for pizza, and I’m jut pleased to say that our teams in our corporate restaurants have significantly improved overall satisfaction scores in the first quarter compared with a year ago.

Operational excellence was one of the many topics we discussed at the Papa John’s franchise conference in early April. Due to the pandemic, this was our first conference sine 2019, and I couldn’t have been more energized by the excitement I felt from our franchisees about the future of the brand. We had more than 1000 attendees from around the world and there was great optimism for the marketing, operations and development initiatives we have underway. This is evidenced by the continued investment they are making in new restaurants globally. However, despite the fact that we have significantly improved sales in unit economics in North America over the last four years, this is not fully translated into domestic development we want to see based on the white space that we have available.

To help expedite development within the United States, we are partnering with franchisees on providing construction services, including permitting, architectural designs and general contractor management. This allows our franchisees to lower friction points and costs throughout the construction process by utilizing our in-house expertise and leveraging the scale of the Papa John’s system. Early response to this program has been favorable and we anticipate more franchisees taking advantage of this opportunity going forward. To further enhance our development, we began rolling out our new store design last year with a focus on creating a great customer and employee experience. We also took a hard look at value engineering to mitigate construction cost increases.

Our newest store footprint is more aesthetically pleasing, more efficient and easier to build. Going forward, all new builds will have this transformational design. I also remain excited about the opportunity we have internationally. Our opportunity is not just about new unit development, it’s about sustainably and profitably growing all of our restaurants globally. We are making significant investments in our international organization and infrastructure to set us up for long-term success. For example, we are investing in technology and IC capabilities to support sales growth through areas like ecommerce, loyalty and revenue management. We have spoken a lot about our white space internationally. In Q1, we announced the development agreement to enter into India through a partnership with PJP Investments Group.

PJP currently operates more than 100 Papa John’s restaurants across United Arab Emirates, Saudi Arabia, and Jordan. They are a seasoned, successful restaurant operator, and plan to open 650 new restaurants in India over the next 10 years. We see India as an attractive market for Papa John’s and this announcement clearly supports our global expansion strategy, which remains on track to achieve our long-term development target of 1400 to 1800 net new units between 2022 and 2025. I’m also pleased to say that we remain on track to meet our current year development expectations of 270 to 310 net new units in 2023, which at the midpoint represents a 5% increase in total system-wide units and a nearly 20% increase over last year’s net new unit number.

Looking forward, our global pipeline is robust, and I’m confident the investments and strategies we are executing to on today will enable us to capitalize successfully and take advantage of the significant white space we see all around the world. Finally, I want to thank our teams for their commitment to having an innovation mindset. I am pleased to announce that we were just named one of the country’s most innovative companies and ranks first among pizza companies in Fortune inaugural America’s most innovative companies list. We are also identified as one of Forbes best employers for diversity for the third year in a row. We’ve built a truly inclusive culture full of diverse ideas and diverse teams. We believe our inclusive and diverse culture is a core strength of Papa John’s and we are extremely proud of the progress we continue to make.

At this time, I want to welcome Chris Collins, who has assumed the role of our Interim Principal Financial and Accounting Officer. We’re appreciative of Chris taking on this additional role while we conduct a comprehensive search process to identify our next CFO. Before I turn the call over to Chris, I want to emphasize that despite near term challenges and changing consumer trends, our business model is resilient and the underlying demand for our product offering remains strong. We are excited about the challenges and opportunities we have to get better. We’re excited about the new product ideas that we have. The improvements we are making in our operations and the significant white space we are pursuing for new store growth domestically and internationally.

Now I’d like to turn the call over to Chris to provide more color on our first quarter results. Chris?

Chris Collins: Thank you, Rob, and good morning, everybody. I’m excited to speak with you today and look forward to working with you and the Papa John’s team as I take on this interim role. As you read in our earnings release this morning, we continue to deliver top line growth on top of significant gains over the past few years. For the first quarter, global system wide restaurant sales were $1.2 billion, up 2% in constant currency and excluding the franchisee suspended restaurants announced last year. Net unit growth primarily in international markets contributed to the higher system-wide sales. For the first quarter, North America comp sales were flat with last year’s record first quarter sales. A result of a 3% growth in our company-owned restaurants, and a decrease of 1% across franchised restaurants who are coming off a strong first quarter a year ago.

For added color, in the first quarter, we have lapped our largest January ever, when customers were staying closer to home due to the impact of Omicron. On a two year and three year stack, North America comps were up 2% and 28% respectively. International comps were down 6% in the first quarter as inflation continue to pressure consumer spending across markets. Similar to the fourth quarter, the challenges we faced in the UK market had a significant impact on our International segment results. First quarter comps were also impacted in Asian markets due to the Chinese New Year and the loosening of COVID restrictions. Strength in our other international markets especially in the Middle East and Spain partially offset these pressures. Total revenues for the first quarter were $527 million, up slightly from the same period last year when excluding the impact of refranchising in 90 restaurant joint venture in 2022.

Now turning to margins. For the first quarter, adjusted operating income was $39 million compared with $45 million from the same period last year. The year-over-year decline was in line with our expectations as the impact of this significant commodity and wage inflation that occurred throughout 2022 has not fully lapped. In addition, higher G&A expense was driven by annual merit increases and performance based comp accruals, along with higher depreciation and amortization related to our investments in restaurants and technology support. Adjusted operating margins were 7.4%, a 90 basis point decline year-over-year, but slightly better on a sequential basis. Our teams are taking a disciplined approach to managing costs while maintaining our high performance culture and supporting our strategic growth initiatives.

So let’s take a deeper dive into our operating segments. In our domestic company-owned restaurant segment, food basket costs were up 4% compared with the prior year. Labor costs also remained elevated in the quarter. Together, commodities and labor costs represented approximately 200 basis points of a headwind for the domestic company-owned restaurant segment margins year-over-year. Our strategic pricing actions somewhat but not fully offset the higher costs, resulting in an approximate 150 basis point decline in restaurant level margins compared with a year ago. We expect to see further improvement in our domestic company-owned restaurant margins as our team continues to implement the Back to BETTER operational initiatives and food costs continue to moderate throughout the year.

We remain focused on factors which are under our control, offering good value to our customers and running great operations. In our North America commissary segment, first quarter revenues grew by 1% year-over-year, driven by higher costs. As a reminder, our commissary arrangement with North America franchisees enables us to pass through food, labor, and fuel costs on a cost plus fixed margin basis. As a result, higher costs are slightly accretive to commissary operating income, but dilutive to operating margins. For our International Operating segment, adjusted operating come was down in the first quarter compared with the prior year. As discussed on prior calls, the UK is our largest market and the only international market where we own the commissary.

Since this market is more than just a royalty screen, the challenges we are facing have a more pronounced impact on our international profits. Partially offsetting the impact in the UK was a 8% net new unit growth in our international markets when compared with a year ago. Moving on to cash flow and balance sheet. For the first quarter, net cash provided by operating activities was $41 million, up from $25 million a year ago. Free cash flow increased $7 million to $22 million reflecting changes in working capital partially offset by an $8 million increase in capital expenditures. We ended the quarter with ample liquidity, of approximately $240 million in cash and borrowings available under our revolving credit facility and a gross leverage ratio of 3.5 times.

We also continued to return significant cash to our shareholders. During the quarter, we repurchased approximately 210 million in shares. In total, we have repurchased 2.5 million shares and approximately 90 million remains available for repurchase under our current authorization. We also paid $15 million in cash dividends during the quarter. Based on our strong balance sheet and positive business outlook, our board has declared it second quarter dividend of $0.42 per common share or $1.68 dollars on an annual basis. Through prudent management of our cash flows, we’re able to maximize our financial flexibility and our ability to create value for our shareholders in both the short and long-term through a combination of organic growth investments, cash dividends, and share repurchases.

Now to our outlook. Overall, our growth expectations remain unchanged with the long-term outlook we provided on our fourth quarter call. Consistent with our long-term guidance last quarter, we plan to grow our North American comps between 2% and 4% annually going forward. Also consistent with our guidance last quarter, in 2023, we anticipate being at the lower end of this range. From a cadence perspective, we believe North America comps will improve each quarter as we launch new menu innovations, activate targeted offerings for our most value conscious customers and execute our Back to BETTER initiatives. We anticipate our international comp sales will remain under pressure, but will improve each quarter as a macroeconomic environment evolves, including within the UK, our largest international market.

We expect our adjusted operating margins to be comparable to up slightly to the level achieved in 2022 as we benefit from several tailwinds including our Back to BETTER initiatives, positive North America comps, and the benefit of 53rd Week in 2023. Offsetting these tailwinds are the investments we are making in the UK and higher G&A expenses as performance based comp ramps back up. For added color, we expect our second quarter G&A expense to be higher due to the return of our franchisee conference after a three-year pandemic hiatus. In addition, while we expect food and wage inflation to moderate over the longer-term is difficult to predict when and to what extent it will occur in 2023. Taking into consideration that first quarter share repurchases increased our debt by approximately $200 million.

We now expect full year net interest expense to be between $40 million and $45 million. The increased interest expense is mitigated by the share reduction from EPS perspective. Our CapEx remains at $80 million to $90 million as we invest in technology innovation and the opening of new company stores. And finally, our tax rate is anticipated to be at the higher end of our 21% to 24% range. In summary, we continue driving value for our shareholders and setting Papa John’s up for success through our menu innovation, digital enhancements, operational productivity, unit growth, and strategic capital allocation. And with that, I’ll turn the call over to Rob for some final comments. Rob?

Rob Lynch: Thanks, Chris. I’ve said it before, Pizza is a uniquely special food. It almost always brings friends and families together some form of celebration, whether it’s the Super Bowl or a casual Friday night gathering. We believe that the world deserves better pizza and that we deliver it. But we remain hungry for better. I’m proud and thankful for the last 3.5 years, but I’m most excited about the future of this brand. With that, I’ll turn the call over to the operator for Q&A.

See also 12 Future Dividend Kings in the Next 6 Years or Less and 18 Most Selling Phone Brands in the World.

Q&A Session

Operator: Thank you. And as a reminder, we ask that you please keep your questions to one and queue up again for additional questions if needed. Please standby while we compile the Q&A roster. And our first question comes from the line of Sarah Senatore with Bank of America. Please proceed.

Sarah Senatore: Okay. Thank you very much. Question and then a clarification about unit growth. So, on the PJP’s agreement for India, I know, predates you, Rob, but the India was a market that Papa John’s was in and then left a few years ago. And I was just wondering if you could talk a little bit about what’s changed? Whether it’s evolution of the market or the positioning or just that are operating capabilities for your partner there? And the clarification, we just understanding the help you’re giving your franchisees in the U.S. There’s no sort of financial contribution from Papa John’s just offering services and sort of the kind of upfront help that somebody who might be new to building or franchising might need that. Is that correct?

Rob Lynch: Yes, Sarah. Hi. Good morning. So, I’ll answer the second one first. We have standard incentives that we offer for high levels of development across our domestic footprint that hasn’t changed. We have equipment incentives and other types of incentives to spur development. But we haven’t increased that or added any type of unique royalty relief or anything like that to spur development. We’ve created some services and some capabilities. What we heard from our franchisees domestically is it’s never been tougher to get a restaurant build from a permitting standpoint, construction standpoint, while we have great resources to help our franchisees with that. So we set up a model that allows them to tap into our resources to help them with their permitting and construction needs.

So that’s really the only incremental support that we’ve added to the model. We’re really excited about the new restaurant design. Our franchisees are excited about that. We’re — every new model moving forward will look like the new Papa John’s. And I think that’s going to have a nice impact on our sales run rate once we kind of give all of those stores a facelift and bring that new model to market. In regards to India, last time, like you said, it does predate me. I wasn’t here the last time Papa John’s tried to go into India, but I’ve definitely done my homework diligence on why. This is different than the last time. The last time we went into India, we didn’t do a lot of due-diligence prior to entering that market. We went in and try to operate that market pretty much the same way we go into every market.

India is a unique market with different dynamics, different supply chain, different cost structure, and most different is kind of the consumer price sensitivity and the consumer needs for a different type of product. So, we spent about a year and a half working with our franchisee from the Middle East who has done an amazing job building out that region and very successful. And they have gone in along with our support and done a lot of research to understand exactly what the needs are in that market. And so, we’ve built a business model and a business plan that we both believe can be successful. It’s a lower priced offering that meets the needs of the consumers in that market, and it’s going to be a more concentrated effort. We’re going to go city-to-city and build scale in each city prior to gathering restaurants all over the market and fragmenting kind of the resource allocation for those individual markets.

So, it’s a very different go-to-market plan than I understand, we went to market in India in the past, and that’s what gives us a lot of confidence.

Sarah Senatore: Thank you very much.

Rob Lynch: Thank you.

Operator: Thank you. One moment for our next question please. And it comes from the line of Joshua Long with Stephens. Please proceed.

Joshua Long: Great. Thank you for taking my question. I was hopeful we could dive into some of the Back to BETTER operational initiatives that are underway. Understanding that we’re probably early on. But just curious how those are progressing? Maybe you could share some additional color there. You mentioned time out-the-door was getting better. I mentioned that there’s some other kind of early wins, maybe at the store level that you could talk about that might inform this idea of the guidance or outlined by the guidance in terms of improving sales over the course of the year?

Rob Lynch: Yes. Thank you for the question. Yes, it has been transformational in our corporate restaurants. I think I’ve shared this before, but — and it’s probably not a big surprise to anybody in this call. But during the pandemic, staffing that’s so challenging that literally our restaurants and our operators we’re bringing in everybody and anybody from a labor standpoint to try and mitigate the staffing challenges. And really, the primary focus of every restaurant became staffing. And so we lost a little bit of the discipline on the KPIs. We kind of gave ourselves freedom to not meet the standards that we had always focused on in the past in terms of make time and out-the-door times and total into the door times. So, when as we came out of the pandemic and we looked at and we brought in some new leadership.

We looked at all of the KPIs that have historically been so important from to this brand, because this brand has always prided itself on operational excellence. And we recommitted our teams to that discipline to make sure that we had — we were tracking it. We were measuring it. We were reinforcing great behavior. We were addressing outages. And our corporate team just rallied around that. And that’s why we have been able to deliver a 25% decrease in out-the-door times and increase customer service commensurately. So, how does that impact the margin and the productivity moving forward? Well, two ways. One, it gives you greater throughput. You can handle more orders and in the same amount of time, but it also gives you better labor productivity as we continue to operate better as it continues to become part of our DNA, we’re able to allocate our labor much more efficiently and effectively.

So, and lastly, as we deliver better service, we anticipate frequency increasing. As customers’ expectations are met or exceeded, we anticipate that they’re going to order more often from us. So, that’s kind of what’s baked into our operating model moving forward and that’s why we have confidence in our restaurant margin continuing to improve sequentially throughout the year.

Joshua Long: Thank you.

Operator: Thank you. One moment for our next question. And it comes from the line of Chris O’Cull with Stifel. Please proceed.

Unidentified Analyst: Thanks. Good morning guys. This is Patrick on for Chris. Rob, your guidance is obviously the same as positive comps for the year. And I’m curious if you can provide any additional color on current trends since we need to see that come up from the flat comp in Q1. And so, I’m just curious if you’re trending towards that now or the lower end of that range at least or if you still have ground to make up. And if so, flatter, what gives you confidence that you can get there over the course of the year?

Rob Lynch: No. It’s a great question, and its a question I ask my teams pretty much every day. Obviously, we reiterated our guidance for the year to be positive. And obviously, we were in — we are flat in Q1. But the Q1 is definitely our biggest comp quarter. It’s our highest sales quarter. We were positive last year when all of the competition was negative. And so, we knew this was going to be our toughest quarter. As you look out, through the balance of the year, the comps definitely get easier. But that’s not the only confidence. The reason that we have confidence in our ability to change the trajectory. I mean, we today are launching our biggest innovation ever. We’ve got MOD and Doritos, Cool Ranch, Cool Ranch, Doritos, Papadia.

We’ve put in a ton of support behind that. We’ve gotten a ton of amazing food reviews and PR surrounding that over the last week as we’ve kind of prep for this launch. So we’re eagerly anticipating this weekend to see our customers’ reaction. But that’s just the first thing. So we have a great pipeline of innovation throughout this year. We’ve got continued improvements in our company operations that we’re excited about. And then, I think our franchisees have a big opportunity as well to kind of tap into some of these resources that we build on our Back to BETTER initiative corporately, and drive those into our — into their operations. So, that’s all upside in the back half the year, and we fundamentally believe that that’s going to deliver continued sequential comp improvement.