Papa John’s International, Inc. (NASDAQ:PZZA) Q1 2024 Earnings Call Transcript May 9, 2024
Papa John’s International, Inc. beats earnings expectations. Reported EPS is $0.67, expectations were $0.58. Papa John’s International, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Thank you for standing by. Welcome to Papa John’s First Quarter 2024 Conference Call and Webcast. [Operator Instructions] As a reminder, today’s program is being recorded. And now I’d like to introduce your host for today’s program, Stacy Frole, Vice President of Investor Relations. Please go ahead.
Stacy Frole: Thank you. Good morning, and welcome to Papa John’s first quarter 2024 earnings conference call. This morning, we issued our first quarter 2024 earnings release. A copy of the release can be obtained on our Investor Relations website at ir.papajohns.com under the News Release tab or by contacting our Investor Relations department at investor_relations@papajohns.com. Joining me on the call this morning is Ravi Thanawala, our Interim Chief Executive Officer and Chief Financial Officer. Before we begin, I need to remind you that comments made during this call will include forward-looking statements 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 statements 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 additional follow-ups. And now let me turn the call over to Ravi.
Ravi Thanawala: Thank you, Stacy, and good morning, everyone. Before I jump into my prepared remarks, I’d like to convey my appreciation to the Papa John’s team and our Board of Directors for entrusting me to lead the organization as Interim CEO. I’d also like to acknowledge the passion and commitment of our talented team members and highly engaged franchisees who continue to deliver for our customers every day. They are so much to be proud of and excited for as we begin our next phase of growth. We are navigating the current dynamic environment with a balanced approach to delivering improved unit level economics and company operating profits while also investing in the future. As such, in January, we launched our Back to Better 2.0 strategy and in a short period of time, we have achieved meaningful milestones.
In the areas of enhancing national marketing investment and effectiveness, we launched our newest platform innovation, Crispy Cuppy ‘Roni across a trio of products and different accessible price points and introduced an all-new brand platform Better Get You Some, that is part of our deepened commitment to and investment in our new marketing strategy. Regarding our focus on accelerating North America development, we improved the cash-on-cash paybacks on new North America development through attractive incentives. We also remain focused on enhancing unit level profitability and reducing overall build costs for new restaurant development. Finally, on our international transformation initiatives, we established international regional hubs led by proven leaders with direct industry and relevant marketing experience to help drive market share gains in key markets around the globe and are progressing the optimization of our U.K. market with the planned closure of 43 company-owned locations later in May and the active pursuit of refranchising opportunities for other locations.
Our energy will remain focused on laying the right groundwork so we can continue to evolve our business, enhance our long-term performance and create value for our shareholders and ultimately become the QSR pizza brand of choice for consumers and franchisees around the world. Now I’d like to touch on our first quarter performance. In our North America business, results were mixed, but thanks to the highly disciplined approach of our operators, especially in our company-owned restaurants, remaining diligent throughout the quarter. Restaurant-level margins exceeded our expectations, leading to higher adjusted operating income despite near-term sales pressure. In the first quarter of 2024, North America comparable sales were down roughly 2% from a year ago.
This was primarily due to lower transactions as the continued growth in our aggregator channel was more than offset by a decline in organic delivery while our carryout business remained consistent with the prior year. This shift in channel mix also led to a slightly lower average ticket as a relatively profit-neutral revenue from our organic delivery fee decline. Strategic pricing actions by our revenue management team helped to somewhat mitigate this delivery fee impact. In the current environment, we’re also seeing customers become more deliberate in managing their overall order costs. So while our core offering pizza remained higher year-over-year, sides and beverages were lower. It has been my experience that brands that win consumers’ hearts and minds on the most important days of the year, have a unique role in their lives that brands are able to build upon.
We are encouraged by our performance on traditionally high-volume occasions for the pizza category during the first quarter, including Valentine’s Day, Super Bowl weekend and March Madness, reinforcing our confidence in the strength of our brand. From an international perspective, we are pleased with the progress we continue to make in this dynamic environment. As anticipated, our Middle East region impacted our first quarter international comparable sales due to the ongoing conflict in this part of the world. Excluding this region, our international comparable sales were up approximately 1% from a year ago. For the first quarter, 2024 global system-wide restaurant sales were $1.23 billion, down 1% in constant currency compared with the prior year’s first quarter.
The lower sales were largely due to the strong prior year first quarter, which had a benefit of approximately $10 million from the high-volume week between Christmas and New Year’s. The decrease in sales due to the calendar shift was partially offset by 3% net unit growth from the prior year. Total revenues for the first quarter were $514 million, down 2% from a year ago, primarily reflecting a $9 million decrease in North America commissary revenues due to lower commodity prices in the quarter and, to a lesser extent, lower transaction volumes, a $9 million decrease in other revenues, which includes a $5 million impact from the sale of preferred marketing, our formerly wholly owned print and promotions business and a $4 million decrease in domestic company-owned restaurants, reflecting lower transaction volumes somewhat offset by higher average ticket.
Partially offsetting these revenue declines was an approximate $10 million contribution from the 2023 U.K. franchisee acquisitions. Turning to profits. Adjusted operating income for 2024 first quarter was $43 million, up from $39 million a year ago. The key drivers of our improvement over last year’s first quarter include an approximate $2 million benefit from improved North America company-owned restaurant margins and domestic commissary margins, an approximate $3 million benefit from reduced local marketing reserves at our company-owned restaurants, a result of the recent change to our local and national marketing spend requirements and an approximate $4 million benefit from equity forfeitures primarily resulting from the recent CEO departure.
These positive impacts were largely offset by a roughly $4 million year-over-year impact related to the operations of our U.K. franchisee acquisitions when taking into consideration a first quarter 2024 operating loss and the first quarter 2023 franchisee royalty fees. Higher G&A expenses of approximately $3 million as we continue to invest in our restaurants and technology platforms, along with the consolidation of the acquired U.K. restaurants and lower North America comp sales. Adjusted operating margins for the first quarter was 8.4%, up from 7.4% a year ago, primarily reflecting improved margins at our domestic company-owned restaurants and supply chain improvements. Overall, our domestic company-owned margins improved 220 basis points compared with the prior year first quarter.
Driving the improved margins was an approximate 110 basis points benefit from lower food basket costs as we continue to see relief in cheese and dough prices. Lower operating costs and a slightly higher ticket at our company-owned restaurants also contributed to our margin improvement, while labor costs were only slightly higher by approximately 10 basis points. Our teams did a great job in the first quarter optimizing our labor model to meet consumer demand and delivering an excellent customer experience while also adjusting for shifts in channel mix. Moving on to cash flow and our balance sheet. In the first quarter of 2024, net cash provided by operating activities was $12 million, down from $41 million a year ago. After accounting for $13 million in capital expenditures for the development of new domestic restaurants and investments and technology innovation, we generated a cash outflow of $1 million.
This compares with free cash flow of $22 million generated in the first quarter of 2023, primarily reflecting unfavorable working capital changes driven by the timing of payments in the first quarter of 2024. Our liquidity continues to be strong with $260 million in cash and borrowings available under our revolving credit facility and a gross leverage ratio of 3.1 times. Overall, our teams around the globe continue to take a disciplined approach to running the business. We’ve improved restaurant level margins and operating profits through commodities normalization, revenue management and labor optimization in the quarter despite the lower sales. Our efforts are having a positive impact on our bottom line. However, there is more work to do. As I mentioned earlier, in January, we launched multiyear strategic initiatives that are designed to drive higher system-wide sales, enhance restaurant-level profitability and reinvigorate development over the long term in key markets around the world.
I’m pleased to say, while still in early innings, we’ve made meaningful progress against the foundational improvements we are implementing in our marketing platforms, our supply chain and our international operations. First, product innovation remains a cornerstone to our brand promise [ph] of better ingredients, better pizza and will continue to be a focus of our strategy. In April, we launched our newest platform innovation, Crispy Cuppy ‘Roni, which is available across a trio products at different accessible price points. In conjunction with this new platform innovation, we launched a modern refresh of our brand visuals, tone and message [ph] with Better Get You Some. This amplification of our brand is the culmination of our efforts over the past nine months where we focused on improving audio segmentation, building customer loyalty and driving cultural relevance.
This combination of brand and product innovation helps the consumer to appreciate the strong value proposition Papa John’s provides. While it’s only been five weeks since we launched our new brand platform, early research of the campaign showed an increase in the consumers’ purchase intent. Moving ahead, we’re focused on improving sales by our revenue management strategies, ongoing loyalty improvements and adapting our media strategy mix to maximize effectiveness across channels. Second, to support the new brand platform and leverage the scale national investments to deliver, our franchisees voted last year to increase the contribution rate to the National Marketing Fund by 100 basis points of sales beginning in the second quarter. As part of the consolidation to national funding, we made local marketing spend optional for the system.
For our domestic company-owned restaurants, we intend to optimize our local marketing spend in 2024 and still see value in investing in certain local marketing co-ops and brand partnerships within specific markets to build upon the strong community relations already in place. Many of our franchisees are taking a similar strategic and targeted approach given the additional optionality the new marketing fee structure provides. The initial customer response and reviews to our new product innovation and brand platform have been positive, but the highly competitive promotional environment has been a headwind to transactions. We believe Papa John’s perceived value is about providing high-quality product innovation at the right time at the right price.
It is important that we maintain discipline in our limited time offers, pricing strategies and product innovations for the long-term success of the business. Although we won’t hesitate to make short-term adjustments as we deem appropriate on a market-by-market basis to remain competitive. Third, as previously discussed, as part of our Back to Better 2.0 strategy, we’re evolving our domestic commissary business to support additional investment in supply chain productivity. Beginning with the first quarter, we increased the fixed operating margin that our domestic commissaries charge by 100 basis points from 4% to 5%. We plan to continue this annual increase until 2027 when the fixed operating margin reaches 8%. At the same time, our franchisees can now earn incentive-based rebates by delivering higher volumes and new restaurant development.
Through the first quarter, more than 40% of our franchisees are on track to earn a rebate in 2024. As we drive higher volumes through our supply chain model, we intend to reinvest into this segment to increase productivity throughout the system, making our supply chain even more effective. Modernizing equipment, automating processes and negotiating contract renewals as we continue to scale are just a few examples of our opportunities available to Papa John’s. Fourth, unit-level productivity is a primary driver of unit development, and we are confident supply chain efficiencies will deliver improved results over the next several years. In addition, we have been focused on rebuilding and elevating our development team to accelerate North America new unit growth through franchisee cultivation, quality site selection, lower cost to build and quicker speeds to open.
As part of this process, we’re evaluating and revamping every aspect of the development process from general contractor selection and architectural costs to leasehold improvements and furniture fixtures and equipment. These improvements are delivering real-time cost savings and will offer franchisees more resources throughout the development process, in addition to greater contractors, suppliers and equipment optionality based on market and anticipated restaurant volumes. The development incentives announced last November combined with the improving cost to build significantly improves the cash-on-cash payback for our developing franchisees who opened new units in 2024 and 2025. The attractive ROI on new builds and the strength of our brand gives us confidence new unit development in North America will continue to accelerate.
Now moving to our international transformation initiatives. Our number one focus is to ensure we have the right foundation to support and drive long-term success. This means being closer to the consumer, continuing to focus on menu innovation that is locally relevant and making sure we have the right insights to help our franchisees within their markets. In the first quarter, we launched our international regional hub structure with proven leaders that have direct industry and relevant market experience. These hubs are designed to help our international franchisees to drive sales and profitability by aligning global best practices with local preferences and the resources to accomplish our long-term objective of increasing share in key markets around the world.
We are also advancing our efforts to optimize the U.K. business model. Most recently, we announced plans to close 43 underperforming company-owned restaurants later this month. We’ll continue to evaluate our remaining portfolio as well as our franchisee locations, focusing on sales trends, overall profitability and their lease and loan obligations. Through this process, additional strategic closures and refranchising opportunities will be considered as we look to drive profitability and strengthen our franchisee base. We believe with these actions, the U.K. market will become profit accretive in the second half of this year. Finally, we’re investing in our international consumer-facing technology and digital infrastructure to improve purchase conversion, increase customer retention and deliver faster consumer insights to franchisees.
There remains significant white space for the Papa John’s brand internationally. And while we saw more foundational investments to make, we’re confident the actions we are taking are setting our largest international markets up for profitable market share gains over the long term. Looking at our outlook for the balance of the year. For the first four weeks of the second quarter, North America comp sales were down approximately 1% and may remain under pressure in the near term as the challenging macroeconomic environment continues and consumer confidence softens. Because of this, we have chosen to update our full year guidance with a more cautious outlook. If orders remain at a similar level as the past four weeks, we anticipate 2024 North America comps to be flat to down low single digits for the full year 2024.
As a reminder, we are in the early stages of our Back to Better 2.0 investments and are committed to providing updates as the year progresses. Internationally, we remain in a dynamic environment and continue to maintain a cautious outlook on international comps in 2024. Based on the lower sales outlook and assuming we remain at similar levels for the remainder of 2024, we would anticipate 2024 adjusted operating income to be between $145 million and $155 million. Our teams remain focused on executing against our strategies and maintaining cost discipline. We continue to expect benefits from the increase to our fixed commissary margin, our international transformation initiatives, notably the closure of U.K. restaurants we mentioned earlier and an increase in North America development.
However, these benefits will likely be offset by lower North America comparable sales combined with higher G&A expenses and higher D&A expense that have been discussed previously. In terms of other nonoperating expense items, we expect net interest expense to be between $40 million and $45 million, our capital expenditures to be between $75 million and $85 million and our tax rate to be between 23% and 26%, all consistent with our prior guidance. From a development perspective, the North America market is our most accretive development for Papa John’s, and we remain committed to accelerating the expansion of our domestic footprint moving forward. In the first quarter, we added 14 net new North America units, bringing our total North America restaurant count to 3,447.
For fiscal year 2024, we expect net new units for North America to increase more than 20% relative to 2023 net unit openings. From an international perspective, we saw 23 new restaurant openings on a gross basis. These new restaurant openings were offset by 29 closures, primarily in certain Middle East markets and China. This brings our total international restaurant count to 2,467. We are maintaining our cautious approach for our international markets and expect gross openings between 100 and 140 new international restaurants for fiscal 2024. We continue to review the performance of our international franchisees and may initiate additional strategic closures to improve marketplace health or exit unprofitable locations. As such, our net openings could be impacted by the closure of underperforming locations to enhance long-term profitability.
Finally, as we look to the longer term, we continue to see significant opportunities to drive higher system-wide sales, global development and overall profitability as we continue to execute on our strategy. Given the current dynamic environment and business trends we discussed today, our longer-term targets are under evaluation as we want to ensure our goals are achievable and aligned with our strategy. In summary, we are executing against our Back to Better 2.0 strategy. This strategy is designed to drive restaurant profitability, improve supply chain efficiency, increase marketing effectiveness and to reinvigorate global development. We are making steady progress as our teams are collaborating across departments and geographical borders, laying a solid foundation for our next chapter of growth.
I’m confident in the strength of the Papa John’s brand, our team, our company’s long-term performance potential. I look forward to sharing our progress with you throughout the coming year. Now I’ll turn the call over to our operator to take your questions.
See also 25 Countries with the Highest Home Ownership Rates and 16 Biggest Publicly Traded AI Companies in the World.
To continue reading the Q&A session, please click here.