Papa John's International, Inc.

cheese prices, third quarter North America median unit profits rose to the second highest level that we have seen in several years, surpassed only by the previous quarter. This was great news for our franchisees and for our company-owned stores' contribution to our bottom line. I want to emphasize that from the beginning of the pandemic, we have made investments and taken decisive actions to protect our team members and customers, including quickly reengineering our ordering and delivery processes, and technology to integrate no contact delivery into our channels and customer experience. It was these actions and the perseverance of our team members and franchisees that built trust with our customers and team members and enabled our corporate and franchise stores to stay open and serve our communities. Turning to technology, one of our competitive advantages is that at our core, Papa John's is an e-commerce first business. with approximately 70% of our orders placed over digital channels and mobile ordering being our fastest-growing platform. One key aspect of our growth strategy is our partnerships and technology integrations with three of the four top delivery aggregators. Year-to-date, our sales through aggregators have grown by a factor of over three times, which contributed to our industry outperformance in Q3. Aggregators continue to be a big part of our profitable growth story, and we are excited to be one of the largest QS brands on their platforms. Our loyalty and one-to-one marketing platform is also a growth driver and strategic technology priority for us. And our more active segments in particular, they drive outsized revenue compared to non-loyalty customers. To leverage this, we continue to scale our efforts for greater personalization. all with the goal of unlocking greater customer lifetime value. Next, I would like to discuss unit growth and new store development. Though new store openings were mostly paused in Q3, as expected with permitting still delayed by most local governments, Papa John's improved franchisee investment proposition and a new development team to support it are beginning to bear long-term fruit. Last quarter, we saw an uptick in interest from potential and existing franchisees who are attracted to the branch growth and profitability, resilient delivery model, and the potential for new retail real estate opportunities opening in the months ahead. We have made good progress ramping up our development efforts to match that interest with new leadership and resources, and early results show it. Last quarter, we signed the largest traditional store development agreement in North America in over 20 years. This deal will accelerate our growth in the important Philadelphia and Southern New Jersey market. Under the agreement, HB Restaurant Group, who joined the Papa John's system in 2019 and already owns 43 restaurants in the Mid-Atlantic area, will open 49 new stores between 2021 and 2028. We're thrilled to see such a committed franchisee expanding within the Papa John's system. and look forward to growing with them and many more new and existing franchisees over the coming years. Lastly, I'd like to address the transformation of our organization and brand over the past quarter and year as we build our commitment to diversity, inclusion, and winning. In September, we announced another big step forward against this strategic priority. We announced that we will open a second headquarters in the Atlanta area. to complement our existing headquarters in Louisville and our international headquarters in Milton Keynes, UK, outside of London. Our new hub-based organization, which is the outcome of a process we began in late 2019, is an investment in our long-term growth, as well as in our ability to efficiently deliver on the company's purpose, values, and strategic business priorities. We're excited to be expanding in Atlanta, an energetic, diverse, global city where we already have a significant presence. It is our largest corporate-owned restaurant market and the location of our newest and most sophisticated QCC. Atlanta is the home of a large number of consumer and QSR brands and provides great access for us to a deep talent pool. Atlanta's world-class airport will also connect us to the domestic and international markets that are key to our brand's future. Our Louisville headquarters, home for 36 years, remains essential to our long-term success. Under the new organizational structure, the majority of our corporate staff will continue to be located in Louisville. Their experience and dedication providing essential support and managing key infrastructure for our franchisees and customers will continue to be a bedrock of our business. The third element of our new hub design will be an international headquarters based in our current UK offices. Consolidating our international operations in the UK allows for greater collaboration and best practice sharing, reduces travel overheads, and leverages our significant resources located there across our international portfolio. We expect to open our new office in Atlanta in the summer of 2021. We look forward to providing updates as we move forward with our plans. Now that I have discussed our strong Q3 results and how progress against our strategic priorities contributed to them, Our new CFO, Ann Coggino, will address the quarter's financial results in more detail before I return to discuss our outlook. Ann?

Thank you, Rob. I'm excited to be here this morning and look forward to partnering with you and the outstanding Papa John's team. It's a unique moment for Papa John's. Through its value-led transformation and innovation, the company is emerging as a leader in its category, opening enormous opportunities not only domestically but around the world. I want to thank Steve Koch and my new colleagues in Papa John's finance team for their warm welcome over the past month, the extra effort they've made during the transition, and most importantly, the high quality work they've been doing over the past nine months, which has allowed the company to reach this point. I am so very proud to be part of this team. In my role as CFO, my top priorities include driving profitable growth, setting a long-term plan to maximize our potential, and managing our balance sheet and capital to create value for the benefit of our shareholders, franchisees, team members, and all stakeholders. Addressing our investors and analysts on this call, I'd like to say that as CFO, I believe it's a unique privilege to be able to engage with investors and analysts in a two-way dialogue. On the one hand, communicating the company's results, strategy, and potential, and on the other hand, listening and learning from your perspectives. In my experience, this active conversation and engagement with shareholders is absolutely essential to a company's long-term success. Working with Rob and the team, I look forward to continuing to build this relationship with you over the coming months. Now let me turn to our financial results, which mirrored our outstanding operational progress during the quarter. There are four highlights I'd like to call out in particular. First, a 22% rise in global restaurant sales last quarter yielded a tenfold increase in adjusted operating income, clearly demonstrating the business's operating leverage, cost discipline, and earnings potential. I note we achieved these superior results in spite of higher commodity prices and the investments we are making to protect and support our team members. Second, we produced $134 million in free cash flow, defined as cash flow from operations less capital expenditures and dividends paid to preferred shareholders through the end of Q3. This is a reflection of the strong cash generation capabilities of our operating model. Third, we ended the third quarter with net debt of only $210 million, down $140 million from a year ago, and a compliance debt to EBITDA leverage ratio of 2.5 times, indicating the strength, optionality, and security provided by our balance sheet. And fourth, Q3 was the last quarter of our We Win Together franchise support program. This $80 million investment, in addition to greatly improved sales and unit economics, has left our franchisees in a better financial position than ever. And equally, the significant cash no longer required by this program, including nearly $55 million invested over the past four quarters, leaves Papa John's even better positioned to drive earnings and free cash flow growth and ultimately shareholder returns. These factors capture, in a nutshell, why I am so excited about Papa John's opportunity. Working with Rob, one of my top priorities is to align our long-term capital allocation and return priorities with the business's growth, cash generation potential, and strong balance sheet to maximize shareholder value. We've taken an initial step today with a new buyback, and I look forward to developing a comprehensive long-term capital allocation strategy for the future. Now I'd like to turn to our Q3 results. I'll then address some specific points around our outlook, including expected one-time costs associated with our corporate realignment. In the third quarter, we reported earnings per diluted share on a gap basis of $0.35 compared to a loss of $0.10 a year ago. Excluding a $0.03 net impact from special charges in the prior year, adjusted earnings per diluted share rose from a loss of $0.07 a year ago to $0.35 this year. The 42-cent year-over-year increase reflects a 44-cent positive benefit from improved operating results, primarily driven by our continuing impressive North America comparable sales. This was slightly offset by a 2-cent negative impact from the allocation of undistributed earnings to participating securities, primarily the Series B preferred shareholders. Per GAAP, we compute earnings per common share using the two-class method. This means that in addition to preferred stock dividends and accretion, a portion of undistributed earnings that would be attributable to participating securities on an as-converted basis is also deducted from net income at the company level to determine earnings per common share. Note, because the company did not have undistributed earnings before Q2 of this year, that is, our net income did not exceed our common and preferred dividend payments, we had not recorded this deduction to common earnings per share. To clear up any potential confusion about this accounting treatment, we have provided an additional table in this morning's earnings press release. Turning now back to Q3 results, In the quarter, we provided $13.5 million of support to franchisees under the We Win Together program, our last quarter as I mentioned, compared to a total of $11.4 million in support a year ago. On a per share basis, this amounted to approximately $0.31 for the quarter compared to $0.28 a year ago. In the third quarter of 2020, pre-tax income on a gap basis was $20.9 million compared compared to approximately 700,000 in 2019. Consolidated third quarter revenues rose 17.1% to 472.9 million. Excluding the impact of re-franchising 46 domestic restaurants in 2019, consolidated revenues increased approximately 20%. The increase was primarily due to strong comparable sales, as we've described, which drove higher North America commissary revenues, sales for domestic company-owned restaurants, North America franchisee royalties, and international revenues. Now, turning to cash. As I previously described, free cash flow was $134 million in the first nine months of 2020 compared to $15.8 million a year ago. The $118 million increase was driven by higher net income as well as favorable changes in working capital items, including the timing of payments associated with our marketing fund. We paid a cash dividend of $10.8 million to our common and preferred shareholders during the third quarter of 2020. Subsequent to the third quarter, on October 30, 2020, our Board of Directors declared fourth quarter cash dividends of approximately 10.8 million to be paid to common and preferred shareholders. The fourth quarter common stock cash dividends will be 22.5 cents per common share. The new 75 million share repurchase authorization is an additional option we are making available on top of our dividend to enhance shareholder value. With this buyback, our intent is to opportunistically repurchase shares in the open market. The buyback is the logical outcome of our healthy cash position and confidence in Papa John's near and longer-term prospects. I want to emphasize, however, that we see the buyback as one piece of a larger, multifaceted, long-term capital allocation and return strategy. I look forward to providing more color in the future. Now, turning to restaurant development. During the third quarter, we opened 14 restaurants in North America and closed 12 restaurants for a net increase of two restaurants. Internationally, we opened 40 restaurants and closed 29 restaurants for an increase of 11 restaurants. These changes in our unit count exclude any temporary closures as a result of the COVID-19 pandemic. As you know, we withdrew our 2020 guidance at the start of the pandemic, given the volatility and business uncertainty we have faced and have not replaced it. However, I would like to address three specific items related to our outlook and reporting. First, to reiterate my prior comments, we will continue to record an expense for the allocation of undistributed earnings to participating securities whenever net income exceeds common and preferred dividends. This means that, hypothetically speaking, if fourth quarter net income attributable to the company comes in the same as Q3, we will again incur two cents of expense for the allocation of undistributed earnings to participating securities. Second, we expect to incur approximately 15 to 20 million in one-time severance, relocation, and other expenses through fiscal 2021 related to our corporate realignment and new Atlanta office plans. Of this amount, approximately 4 to 5 million, or 9 to 12 cents per share, of one-time expense is expected during the fourth quarter of 2020. As Rob discussed, we see these expenses as an investment in both the company's innovation and top-line growth, as well as in our efficiencies and commitment to reduce overhead. Third, I'd like to comment on our reporting. As you are probably aware, when the pandemic first triggered shutdowns across North America in March, creating extraordinary conditions for the country and our business, Papa John's began to provide monthly updates on comparable sales in addition to our normal quarterly reporting. We've continued to do so since with the goal of providing investors additional transparency during a period of suddenly higher volatility and uncertainty. Though there remains uncertainty and volatility around the impact of the pandemic going forward, on a relative basis, the sudden increase in uncertainty and volatility that initially led us to institute monthly sales reporting has passed. For that reason, we will return to our quarterly reporting frequency going forward in line with our industry peers. As always, we will continue to evaluate our reporting procedures and disclosures based on business conditions and disclosure best practices. I'll now turn the call back over to Rob to discuss our outlook. Rob?

Thanks, Anne. Congratulations on your amazing start as our CFO. We're so thankful and happy to have you as part of our team. I'd like to conclude by discussing how Papa John's is positioned for the short and long term. Papa John's is on a growth trajectory, having now achieved positive North America and international comp sales for five and six consecutive quarters, respectively. And so far in 2020, we have delivered record results and outperformed the overall pizza delivery market every quarter this year. As we look to the future, we expect the underlying factors that have contributed to our performance here to date to continue to benefit us in the longer term. We have built a scalable, sustainable innovation process that is producing winning new menu items, backed by a highly effective marketing model that makes our food the hero and has driven new levels of consumer awareness and favorability. We're just beginning to realize the benefits of these changes. Looking ahead at Q4 and into 2021, we have an exciting pipeline of opportunities lined up across pizza, papadias, and new platforms, which we look forward to telling you about in the near future. The growth in our business this year has connected millions of new customers with our brand, including over 8 million across our digital channels alone. These new customers are showing great promise with a higher portion purchasing multiple times shortly after their first purchase, a strong indicator of their stickiness. Additionally, Papa John's franchisee investment proposition and development capabilities are more compelling today than ever. We also have more domestic and international development white space than other top pizza brands. Together, these factors indicate our great potential for long-term unit growth in addition to continued comp sales growth. So to sum up, at Papa John's, we're working hard to take care of our team members and customers, deliver great pizza, and realize our tremendous potential today and in the future. I'd like to thank our shareholders, and everyone on this call for their interest in our company and for their continued support. With that, I'll turn the call over to the operator for Q&A.