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Edited Transcript of PZZA earnings conference call or presentation 22-Feb-17 3:00pm GMT

Thomson Reuters StreetEvents

Q4 2016 Papa John's International Inc Earnings Call

LOUISVILLE Feb 22, 2017 (Thomson StreetEvents) -- Edited Transcript of Papa John's International Inc earnings conference call or presentation Wednesday, February 22, 2017 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Lance Tucker

Papa John's International, Inc. - CFO

* John Schnatter

Papa John's International, Inc. - Founder, Chairman and CEO

* Steve Ritchie

Papa John's International, Inc. - President and COO

* Mike Nettles

Papa John's International, Inc. - CIO and Chief Digital Officer

* Robert Thompson

Papa John's International, Inc. - SVP of Marketing

* Sean Muldoon

Papa John's International, Inc. - Chief Ingredient Officer

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Conference Call Participants

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* Alex Slagle

Jefferies LLC - Analyst

* Will Slabaugh

Stephens, Inc. - Analyst

* Chris O'Cull

KeyBanc Capital Markets - Analyst

* Peter Saleh

BTIG - Analyst

* Alton Stump

Longbow Research - Analyst

* Mark Smith

Feltl and Company - Analyst

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Presentation

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Operator [1]

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Good day, ladies and gentlemen. Welcome to the Papa John's fourth-quarter 2016 conference call and webcast.

(Operator Instructions)

I would now like to introduce your host for conference call, Mr. Lance Tucker, CFO. You may begin, sir.

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Lance Tucker, Papa John's International, Inc. - CFO [2]

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Thank you, Kevin. Good morning. Joining me on the call today are our Founder, Chairman and CEO, John Schnatter, and our President and COO, Steve Ritchie, as well as other members of our Senior Management Team. After the financial update, John and Steve will have comments about our business and the Management Team will then be available for Q&A.

Our discussion today will contain forward-looking statements that involve risks related to future events. Actual events may differ materially from the projections we discuss today. All forward-looking statements should be considered in conjunction with the cautionary statements in our earnings press release and the risk factors included in our SEC filings. All statements made on this call are as of today.

Please refer to our earnings press release and the Investor Relations section of our website for a reconciliation and other disclosures related to our discussion of non-GAAP financial measures on this call. Unless otherwise noted, all comparisons are versus the comparable periods from a year ago. This call is being taped and the replay will be available for limited time on our website and in downloadable podcast format.

Now for discussion of our fourth-quarter operating results. Diluted EPS in the fourth quarter was $0.88 on a GAAP basis. Excluding special items, adjusted EPS was $0.69, up 11% over 2015. We ended the full year 2016 with diluted EPS of $2.74 on a GAAP basis. Excluding the special items, adjusted EPS was $2.55, an increase of 22% over adjusted 2015 EPS.

Fourth-quarter revenues were up 5.5%, mostly driven by 3.8% higher comp sales in our North American restaurants. In addition, international revenues were up nearly 9%. We opened 126 net global units in the fourth quarter and 204 for the full year, with 151 on the international side and 53 in North America.

On a business segment basis, adjusted operating income for domestic Company-owned restaurants increased $1.2 million, due mainly to 4.8% comp sales increases, a 3.2% increase in units and lower commodities. These increases were partially offset by increased labor costs and higher non-owned automobile insurance costs.

Operating income for the North American franchise that was up $2 million, due primarily to 3.4% comps and lower sales and development incentives. Operating income for our domestic commissary segment was down $200,000, due to planned lower margins to attain our annual profit commitment. This was a timing difference only, as our full-year results were higher due to higher restaurant sales volumes.

Fourth-quarter operating results for our international segment decreased approximately $300,000. We generated 5.6% comps and did unit growth. However, the higher profits that resulted were offset by a negative foreign exchange of $800,000 and the timing of marketing spend in the United Kingdom.

Our unallocated corporate expenses, excluding special items, increased versus 2015 by $700,000, primarily due to an increase in salaries and benefits, including higher incentive compensation from higher annual operating profits as well as higher interest expense. Lower medical claims costs partially offset these increases. Our effective tax rate was 32.2% in the fourth quarter and 31.3% for the year, with each approximating the prior year's tax rate.

We repurchased $13 million of stock during the quarter and $122 million for the year at an average price of about $57 and currently have just under $130 million of remaining share repurchase authorization. Our free cash flow, non-GAAP measure we define as cash flow from operations less capital expenditures, was approximately $88.5 million in 2016, down from 2015, mainly due to the payment of a previously disclosed legal settlement of $12 million as well as higher capital expenditures, including investments in our new Georgia QCC.

Moving to 2017, highlights of our outlook for the year include diluted EPS growth of 8% to 12%, including the 53rd week. This growth is before the impact of the new equity-based compensation accounting guidance. North American comp sales of 2% to 4%, international comp sales of 4% to 6%, new unit growth of 4% to 5%, primarily coming in the second half of the year and capital expenditures of $45 million to $55 million. Please see the press release for our complete 2017 financial outlook.

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

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John Schnatter, Papa John's International, Inc. - Founder, Chairman and CEO [3]

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Thanks, Lance, and good morning, everyone. Thanks for joining us in the call today as we discuss our fourth-quarter and full-year 2016 results. I'm pleased with our fourth-quarter results, with good comp sales leading to another quarter of solid earnings growth. For the full year, we delivered 22% EPS growth and 3.5% comps for another year of strong performance from our corporate and franchise operators.

We have an unmatched commitment to quality, with a consistent operating model that allows for sustainable growth and a best-in-class digital (technical difficulty), all of which have contributed to our excellent performance for many years, but none of that matters without the incredible team members of Papa John's that pull it all together. You might have seen our new brand campaign that highlights the Papa John's pizza family. The family campaign highlights our most important ingredients, our people.

We brought the dream to bake extra pizza to life with new commercials just hours ahead of Super Bowl LI. The ad features the key milestone (technical difficulty) journey, showing my Camaro knocking out the wall of the broom closet at my father's tavern, installing a pizza oven and selling the first Papa John's pizza. It's the story of how we built our pizza company. For the first time we featured team members, real members at Papa John's in TV spots and the new Papa John's logo.

None of the financial or operational success would be possible without our pizza family, our suppliers and quality control centers, franchisees, delivery drivers, pizza makers and our loyal customers. Each has played a role in achieving the success and I'd be remiss to talk about our result about thanking all of them for their contributions.

Moving back to some highlights from the fourth quarter of 2016, adjusted EPS was $0.69, up $0.11 over -- or 11% over 2015. These results were driven primarily by strong domestic and international comp sales and unit growth. Comp sales in North America were up 3.8%, with international up 5.6%.

We rolled out our biggest product launch of the decade, our new handcrafted pan pizza, which is been very well received by our customers. Our pan pizza is made with simple, clean ingredients like fresh, never-frozen pan dough with no artificial flavors or synthetic colors. The fresh pan dough is topped with hearty tomato sauce made from fresh-packed California tomatoes and of course it tastes great.

Speaking of quality ingredients, 2016 was another stellar year for Papa John's. Since I open first Papa John's pizza, we've been committed to providing families with highest quality pizza and other menu items with the highest quality ingredients. We continue to deliver on this promise to our Papa John's pizza family today.

In an open letter to moms and dads of America, we made a promise in July of 2015 to remove 14 unwanted unnatural ingredients from our menu by the end of 2016. I'm proud to say we kept our promise and completed our mission to move these 14 ingredients from our menu a few months ahead of schedule.

We opened 126 net units in the fourth quarter, including our 5,000th Papa John's restaurant, a milestone very few in the industry have obtained. We enter the with 5,097 global units are now in all 50 states and 45 international countries and territories. We recently announced development deals and expansion plans in Columbia, Mexico, Egypt and (inaudible). I'd like to say a special thank you to Tim O'Hern and his dedicated development team for making this happen.

On a partnership front, our NFL and MLB sponsorships continue to keep us front and center with sports fans, a key demographic in the pizza business. I'm proud to announce that we've expanded our partnership with Don Schumacher racing and one of NHRA most exciting drivers, Leah Pritchett. Leah's off to a blazing start in 2017, clocking the fastest time in NHR Top Fuel at a testing and winning this season's kickoff race in Sonoma.

Additionally, welcome the NHR family to the Papa John's pizza family, becoming the coming official pizza partner of NHRA. As the only brand in the sport, we look forward to connecting with fans at races throughout the country and expect this partnership to pay big dividends in years to come. Our pizza family includes our long-standing partners and suppliers. This quarter we partnered with PepsiCo to offer pizza fans better experiences at Super Bowl LI. The Halftime of a Lifetime sweepstakes gave fans the once-in-a-lifetime opportunity to get front row seats at Pepsi Zero Sugar halftime show at Super Bowl LI.

To conclude, fourth quarter of 2016 was one of the most eventful in our history, with the opening of our 5,000th store, the pan pizza rollout and the challenges presented by a very competitive pizza category. Wrapping up 2016 with a milestone opening and product launch, along with the strong financial numbers we delivered, makes me excited about what Papa John's family has achieved and even more excited about what this team will accomplish in years to come. With that, I'll turn it over to our President and Chief Operating Officer, Steve Ritchie. Steve?

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Steve Ritchie, Papa John's International, Inc. - President and COO [4]

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Thank you, John, and good morning, everyone. I'd like to start by thanking our 120,000-plus team members in over 5,000 stores around the world for delivering another strong year for the Papa John's brand. As John stated, in the fourth quarter our domestic comp sales were a solid 3.8% for North America, marking our 25th consecutive quarter of positive comps sales and our 3.5% full-year comps mark our 13th consecutive year of flat or positive sales growth. These strong results produced another year of record sales and profitability for both our corporate and franchise restaurants.

As John mentioned, in mid-October we launched our high-quality fresh, never-frozen pan pizza. We introduced the product in a value price of $10 and experienced high engagement in trial of the product from our customers. Overall customer feedback has been very positive and we now have another best-in-class product to differentiate our brand, with more opportunity for future category share growth.

On the international front, our Q4 comps were also solid at 5.6%, representing our 28th consecutive quarter of positive comp sales and we delivered strong full-year comps of right at 6%. It was also an important year for international growth, opening a record 6 countries in 2016 and setting the stage for strong development growth for 2017 and beyond. With now over 1,600 international stores in 45 countries, another 1,400 and growing in the development pipeline, our confidence in the future of the international business is unquestionable.

From our humble beginnings in a broom closet back in 1984, our primary source can be attributed to -- our success can be attributed to our most important ingredient, as John stated, our people. At Papa John's, we're more than a pizza company; we are a pizza family. We believe our continuous commitment to enhance culture and quality will further differentiate our premium brand from the rest of the industry.

Like we've said before, our customer expense will never exceed our team member experience. Our new brand campaign launched in February spotlights not only our Founder's entrepreneurial journey and the sacrifices he made along the way, but also highlights our team members. We have real team members featured in our national television spots, the new logo lock-up with John and all our new pizza family boxes. We're sharing many of our team members' inspirational stories at papajohnspizzafamily.com. This new campaign was created to share our authentic brand purpose, heritage and reason for being with the rest of the world.

As our brand grows, so does our need for increased national marketing investment. I'm pleased to announce we have entered into a multi-year agreement with our domestic franchisees to increase our national marketing fund contribution rate from 4% of net sales up to 5% and a quarter point per year over the next several years. The increased national investment will enhance our overall brand exposure, with more focused allocations in the digital, mobile, social media and multicultural to competent our national TV and partnership efforts.

On the technology front, we just recently announced some very exciting news, hiring our first-ever Chief Information and Digital Officer. We're excited to welcome Mike Nettles to the Papa John's team. Not only is Mike a great cultural fit for our Company, but he is also a proven leader in the detail -- digital and retail sectors that will help us deliver a better customer experience and elevate our digital platforms. We will continue to push for new innovations, but we'll be sure they align with our vision, positioning brand promise and never sacrifice quality.

I'm confident Mike's leadership capabilities and vision will enhance our current strategic plan to enable Papa John's to continue taking share within the pizza category. We are only scratching the surface of our future opportunities with the vast evolving digital landscape.

Mike is, however, starting with a strong framework, as we were recently awarded Technomic's 2017 Chain Restaurant Consumer Choice Award for the Use of Technology Improves the Customer Experience. The award complements our leadership position in the industry and customer experience across digital platforms. One great example, we now have a category-leading five simple, secure and mobile friendly ways to pay for your order online without using cash or credit card, those being PayPal, Visa Checkout, PayShare, Papa Rewards and Papa John's own gift cards. Look for 2017 to be another year of exciting digital innovation for the Papa John's brand.

As John highlighted, our pizza family continues to deliver on its promises to up the ante with quality. I'll be remiss not to mention our outstanding R&D team and our suppliers, which enable us to continue to simplify our ingredient labels without sacrificing the taste that our consumers have grown to love.

As the recognized leader in quality, we must walk the talk and continue to find new ways to get better each and every day. The research shows our growing consumer base of Millennials and Gen Zs demand accessibility, transparency and simplicity in their pizza ingredients. Doing the right thing with ingredients has never been a debate for us at Papa John's, which is why I'm proud to say in 2016 we are the first in the pizza industry to announce that we removed all artificial flavors and synthetic colors from our entire menu.

In closing, we are very proud of our 2016 global comp sales results, our strong unit growth and 22% EPS growth. In addition to our efforts on new products like pan pizza, leadership in technology, Clean Label and improving our customer experience through our culture-first approach, we continue to live out our promise of better ingredients, better pizza. With that, I'll turn it back over to Lance for questions.

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Lance Tucker, Papa John's International, Inc. - CFO [5]

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Kevin, we're ready for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions)

Alex Slagle, Jefferies.

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Alex Slagle, Jefferies LLC - Analyst [2]

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Thanks. Good morning. I have a question on the fourth-quarter domestic same-store sales seem to slow a little bit on the two- and three-year basis. If you could just walk us through what you're seeing out there and how we should interpret the 2% to 4% comp for 2017, the guidance. It seems like the same place you started last year. Any thoughts on that?

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John Schnatter, Papa John's International, Inc. - Founder, Chairman and CEO [3]

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Steve, you want to take that one?

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Steve Ritchie, Papa John's International, Inc. - President and COO [4]

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Sure, John. Alex, love to take it. It's Steve. I think a couple of comments. First off, our two-year comp is a little lighter, as you said at 7.7%, but our three-year comps are really pretty much in line. I think we were at a 14.4% and relatively close to that the last couple of years. I believe 2015 was 14.9%. 2014 was 14.3%. Our annualized comps have been roughly in that neighborhood, just south of 5%. I feel pretty good about the overall trends that we are seeing.

Specifically, though, to your comment on the fourth quarter, and this was very much intentional as we talked about -- I talked about this on the last call just a bit. With the introduction of our pan pizza which, as we had stated, is a fresh, never-frozen product, it does require some operational change and adaptations so we did reduce a little bit of our marketing activities in the fourth quarter to provide the opportunity for operators to adapt to that product.

With that being said, there is a couple of other factors that we tried to quantify those contributing pieces to our sales performance, which we are clearly very proud of, a 3.8% comp in the fourth quarter, given the industry trends as you guys have seen out there. In fact, I think of those that have reported thus far, we are in the top three across the entire restaurant industry. We feel good about that.

Let me talk about the NFL for just a moment. The NFL trends, if you've seen the ratings on the year-over-year basis, they were down 8% on the full year for the season. Given the fact that we have significant investment into the NFL, an 8% decline in ratings does play a small factor in some our performance. The competitive activity in the fourth quarter against some of the -- with major chains knowing that we intended to launch our pan pizza in the fourth quarter, we did see an increase in activity and we saw a slightly more aggressive pricing in the fourth quarter and that has continued into the first quarter.

I think overall I feel good about the fourth-quarter performance. Just to talk a little bit about first-quarter performance, some of the trends that we saw in the fourth quarter have continued into the first quarter. Obviously the NFL season did continue into the first quarter. We saw the same softness and we had some real advantages, as you might recall, last year with Denver Broncos and Peyton Manning and that Super Bowl L and the hug, of course, at the end of the Super Bowl game.

Those were things that clearly provided some advantages we had hurdle over, in addition to we have about 160 sports partnerships across all sports in the US. We've had some disadvantages in terms of the activation amount. These are not significant numbers but they are factors into some of our performance.

It's been slightly unseasonably warm in the first quarter, so we're experiencing a little bit softer sales in the first quarter because of those and the continued competitive activity all of the national players, but I feel really confident on our 2% to 4% full-year comp. Just like last year, we had a slightly softer start in the first quarter, then of course as you can see, we pulled it out and came in with a 3.5% for the full year. Sorry to be long-winded, but wanted to cover a lot of that territory as it relates to sales.

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Alex Slagle, Jefferies LLC - Analyst [5]

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Got it. That's very helpful. If you could provide an update on your digital initiatives. I know you touched on it a little in prepared remarks, but with Mike as your new CIO and already made lots of progress with the digital order mix now up to 55%, what's the top priority for 2017, if you could share that?

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Steve Ritchie, Papa John's International, Inc. - President and COO [6]

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Sure, Alex, I would love to. We're clearly very excited to have Mike on board. He's bringing the type of thought leadership that's really going to drive our overall strategy.

With that said, we've had a lot of success. We're fast approaching 60% of our business on the digital side of the overall sales. Clearly, our digital business is very strong. If you think about our focus areas, to your question, it will continue to be on areas to enhance the customer experience, to drive more throughput, to drive the increases in overall conversion rate. With that said, innovation is going to be a big priority. The addition of Mike to the team provides us the opportunity to take the innovations out of business to the next level.

We've done a number of things in 2016. I think you'll see even more things coming out in 2017 from a competitive standpoint. I clearly don't want to speak to those specifically, but we're pretty darn excited about what is to come on the digital side for the Papa John's business.

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John Schnatter, Papa John's International, Inc. - Founder, Chairman and CEO [7]

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Mike, why don't you give an overview of what you've seen in a high-level very quickly, the first two weeks of being Papa John's.

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Mike Nettles, Papa John's International, Inc. - CIO and Chief Digital Officer [8]

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Sure. Thank you, John, and I appreciate the opportunity. The reality is when you look at the restaurant space in general and look at with the industry is doing, you have to look holistically at the total customer journey. Is not just a matter of hey, we've got an online ordering system as a supplement to our business. We actually have to look at how do we integrate that into our daily routines and our daily lives and our interactions with the customers who frankly are extensions of that pizza family image that we really believe in and we really support.

Meeting them where they are, where they want to be, recognizing they've got a lot of choices, they can be driving on the way home and saying, I need a quick meal for my family. How do I get them to interact with us in such a way that meets that particular need, whether it be through a simple carry out or even through some of our mobile or some of our other e-commerce systems.

Frankly, as Steve has already said, we're in a great position. We've done a lot of the plumbing and a lot of the processes are in place today to already enable and integrated a digital experience. I just think we have plenty of opportunities to take this to the next level by really considering the demographics in the customer segments we have, really targeting some of those segments very, very tactically in certain areas, but so that all wraps together in a cohesive strategy so that I can actually work closely with our marketing teams and our operations teams to deliver technology solutions that make it easier for guests to do business with us however they choose to do so, be it through online, through mobile, through walking in, through the delivery, though the touch point of the delivery, there are so many unique things we actually have available to us.

We just have not found a way to stick into that digital strategy yet, but I'm confident we're going to. We've got the right plumbing in place and I'm excited to work with the team that's here to get us to that next level.

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Alex Slagle, Jefferies LLC - Analyst [9]

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That's great. Thanks, Mike.

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Operator [10]

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Will Slabaugh, Stephens.

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Will Slabaugh, Stephens, Inc. - Analyst [11]

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I wanted to ask you a little bit more about pan and how that worked for you. Would you consider that launch a success? It sounds like you were happy with the trials there, so I wondered if you could speak a little bit to the trial versus what you expected and then any average ticket impact that you saw, given that $10 initial price point.

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John Schnatter, Papa John's International, Inc. - Founder, Chairman and CEO [12]

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Yes, Steve, I will take this at a high level and then you can give him the details. The mix, we hit it dead on. We plan on being at 22% and we hit 22%. I do think competitive nature of the other -- some of the other competitors were doing $6 and $7 pans and were doing $10 pans. But frankly, I don't think it's could've gone any smoother from an operational and executional point of view. Steve?

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Steve Ritchie, Papa John's International, Inc. - President and COO [13]

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Thanks, John. To John's point, right in terms of the level of mix we that anticipated, consumer feedback, which is obviously the most critical, likability of the product, it is a premium product. We have a number of mechanisms, i.e., using NPS. We got a lot of good feedback on the product.

It's a little early to understand repeat business and frequency as it relates to the product, but overall, I think we're very pleased with it. It's another weapon within the arsenal for us to be able to compete. We were the last, I guess, in that pizza category among the chains to introduce the pan product, but we do think clearly is an opportunity to not only drive frequency for our business, it's an opportunity to take share.

In terms of the overall ticket average, at the promotional price at $10 there was no material difference in what you've seen in some of our other promotions. The overall food cost on that product is also relatively consistent with what you see with some of our large promotions.

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Will Slabaugh, Stephens, Inc. - Analyst [14]

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Got it. That is helpful. If I could follow-up with one additional question, just more high level. As we continue to the space become more competitive, they are apparently reacting more quickly to what you're doing, consumers are volatile, et cetera. Can you speak to how you guys can continue to seceded and then maybe even accelerate that momentum that you have been seeing, given what's going on out there? The crux of the question is, does this mean that given the competitive activity Papa John's needs to continue going upstream and pushing quality, quality, quality and maybe that means additional ticket, or am I thinking about that a little bit too aggressively on the premium end?

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John Schnatter, Papa John's International, Inc. - Founder, Chairman and CEO [15]

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I will take the big part of it then Steve or Robert, you can take the marketing. The fundamentals of the Company have never been better. Our food, our pizza scores, our service, our culture is at an all-time high. You can feel it when you come in the building, when you go in the restaurants. The things that got us successful over the last 32 years are well in place.

The things I think are going to get us ahead are this Clean Label initiative that Sean will do and his team are working on. Then of course the technology. The technology, we're now, what, at 60% digital mix or approaching that's going to go to 80%. Sooner or later, that's going to 80% and that's why we brought Mike in. Robert or Steve, you want to talk about some of the initiatives that we're doing?

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Steve Ritchie, Papa John's International, Inc. - President and COO [16]

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Sure, John. It's Steve and Robert might jump in as well. I think to add to your point, the technology advantage clearly with the percentages of sales there is key, but it also provides us with the pace of play and speed to be able to adapt to an ever-changing, evolved environment as it relates to price, so having that many of our consumers within our online database, leveraging our very powerful loyalty program of (inaudible) rewards, we feel really good about our opportunity to be able to adapt.

What you won't see is us walking away from quality. Quality is who we are and that's a key differentiator for the last 13 years of our growth and I believe it will be for the next 13 years. The key thing is balance. Understanding the right level of balance with the promotional activity, with what we convey from a branding perspective and what happens at the individual restaurant level. It's all about execution at the individual restaurant level from the ops to the service experience to what we do from a local store marketing standpoint.

As I mentioned before, we have 160-plus partnerships and those are local partnerships, so leveraging those to -- as the smaller player amongst the chains within the category, making our dollars and our activities work harder for us is how we've been successful and we'll continue to do so. Robert, I don't know if you'd mention anything else that we have going on out there.

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Robert Thompson, Papa John's International, Inc. - SVP of Marketing [17]

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I would just add, complement both what you and John have spoke to. The big part about a pizza family is really understanding the different dynamics within that family, making sure that we are very targeted and segmented, leveraging our rewards consumers, providing those value offers to consumers who need that while providing that higher price new product news that we will constantly develop and offer out there in the landscape of the pizza environment to those type of consumers, so really getting segmented and leveraging our technology to do so.

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Will Slabaugh, Stephens, Inc. - Analyst [18]

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Thanks, guys.

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Operator [19]

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Chris O'Cull with KeyBanc.

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Chris O'Cull, KeyBanc Capital Markets - Analyst [20]

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Thanks. Good morning, guys. Steve, I wanted to clarify or wanted make sure that your sales comments, that I understood these. Is it fair to say the first-quarter domestic comps are below the full-year guided range of 2% to 4%?

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Steve Ritchie, Papa John's International, Inc. - President and COO [21]

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I don't want to get into specifics, Chris, but I would say that in general we are softer than we experienced in the fourth quarter. Some of the competitive activity -- obviously, we don't get into cadence within the quarter and we still have one whole period to go. We've a lot of activities things. There's a number of things that are just out of balance in January and February that's creating a little bit of the softness. That softness in the fourth -- first quarter also ties into what we are guiding against from an EPS perspective. There's a lot of headwind this year versus tailwinds last year, but we always make the appropriate changes to get the full-year back on track.

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Chris O'Cull, KeyBanc Capital Markets - Analyst [22]

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Part of a follow up, then, is what gives you confidence that comps can accelerate on more difficult comparisons, because I think last year you started out with difficult comparisons and then things got easier, which you were able to obviously benefit -- you comped really well against. How do you think about it playing out this year?

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Steve Ritchie, Papa John's International, Inc. - President and COO [23]

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I will speak to somewhat similar what we did last year. The underlying strength of the core business, and I'll hit four areas, I won't be long winded with it, but quality, branding, technology and culture. Each of those four strategic areas, really the catalyst of our growth and the future of our business, are getting stronger and stronger. Those things are always challenged when the competitive environment gets extremely aggressive with pricing and not just within the pizza category, but it has a tendency to go beyond pizza into QSR and casual dining. Those are factors that we have to mitigate against, but I feel really good about the strength of that and our opportunity to get even stronger over the trailing three quarters.

Mike Nettles spoke for a while on the digital side. We're clearly very excited about the opportunities that we have over the next three quarters with the addition of Mike and implementation of some of our initiatives to continue to grow traffic and drive the overall sales business.

Promotional, clearly extremely aggressive in terms of pricing in the first quarter. Our promotions in the first quarter were not necessarily as aggressive some of our competitors in the first quarter, so we will make adjustments where necessary, whether that from a national perspective or local or on the digital side and we will do so to ensure that we continue to take share.

The last thing I will note is execution at the operations side is Edmond Heelan, who oversees our North American business for our franchise and corporate side. They continue to get better and better at product quality and service execution and there's a number of initiatives that we'll be continuing to put in motion for the duration of the year. Those factors will drive retention and repeat purchase from our consumers and get us back on track to the 2% to 4% full year.

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Chris O'Cull, KeyBanc Capital Markets - Analyst [24]

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Will the increase in the national ad contribution rate have any impact on the 2017 funds?

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Steve Ritchie, Papa John's International, Inc. - President and COO [25]

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Thanks for asking that, Chris. As you saw, as you probably heard me say, we have a quarter point year that's coming in. That was folded in late into the fourth quarter of last year. Modest in terms of the investment coming into 2017. As you may be aware, we are fighting some headwinds in terms of media inflation, specific media inflation to sports on the national television side and we buy a significant amount of our media with sports.

We're doing some reallocations and incremental investments into the digital, social media side and some multicultural. So I anticipate it to be a factor, not a significant factor, but as the national investment continues to grow up to the 5% over the next three, three and-a-half years here, it will be a contributing factor to our overall growth.

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Chris O'Cull, KeyBanc Capital Markets - Analyst [26]

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Okay, thank you. One last one and I'll get back in the queue. Cost of sales at the Company restaurants were down in the fourth, which was a little surprising given the spot price of cheese was up year over year. What drove the improvement?

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Lance Tucker, Papa John's International, Inc. - CFO [27]

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This is Lance. I'll take that one. You're right, block was up a bit, but both our meats and our dough were down fairly significantly in the fourth quarter, certainly more than enough to offset what was really a very slight cheese headwind with us, because we did, with our forward pricing arrangements, mitigate a good bit of the cheese increase. Dough and meats were better and cheese was not too bad.

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Chris O'Cull, KeyBanc Capital Markets - Analyst [28]

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Will the meat and dough benefit continue for a while?

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Lance Tucker, Papa John's International, Inc. - CFO [29]

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Certainly it'll be built into the guidance we have for 2017. Overall, we are expecting the commodity basket in 2017 to be actually a little bit up, so cheese is going to continue to go up. We're about 50 to 150 basis points up is the range we are projecting right now. The meat and the dough will continue to help some but cheese is going to bite into it more than it did in the fourth quarter, certainly.

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Chris O'Cull, KeyBanc Capital Markets - Analyst [30]

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Great. Thank you, guys.

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Operator [31]

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Peter Saleh, BTIG.

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Peter Saleh, BTIG - Analyst [32]

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Great thanks. I wanted to ask about the increase in the ad fund. Do the franchisees have to vote on this increase?

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John Schnatter, Papa John's International, Inc. - Founder, Chairman and CEO [33]

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Yes, Peter, this is John. They did vote and Steve, you can get specifics but I think 95% of the system, which is unheard of, voted to increase it from 4% to 5% over a four-year period.

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Steve Ritchie, Papa John's International, Inc. - President and COO [34]

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You are exactly right, John. It was exactly 95%, which is a complement to the confidence in the investments that we have made in our national marketing as we increased it from roughly 3% up to 4% five years ago in some of those investments into the NFL partnership, the Major League Baseball partnership, some of the things we've done with player associations and incremental national television and digital.

That is direction we will continue to go, but is very important for our brand to balance the local investment in the national, our national marketing funds going up to 5% but our overall investments are between 8% to 9%. So still roughly half or so that's happening at the local level.

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John Schnatter, Papa John's International, Inc. - Founder, Chairman and CEO [35]

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Peter, (technical difficulty) this is a -- I give all the credit to Steve and his team. The relationship of the franchisees and the relationship with the Franchise Advisor Council is probably at an all-time high. There's a lot of confidence in the system and a lot of confidence in this Leadership Team.

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Peter Saleh, BTIG - Analyst [36]

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Great. Real quick on the Clean Label investment you guys have been making, do you feel we are getting rewarded or paid for that for the investment you are making, or is that yet to come?

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John Schnatter, Papa John's International, Inc. - Founder, Chairman and CEO [37]

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Sean Muldoon, I will let you jump in here, but just give you directionally how this is going, four years ago, 7% really were concerned about the ingredients in the ingredients. That number is now 38%. That's where it is headed. The educational and informational aspect of knowing what's in food is growing. It's important to the Millennials and I think it's going to be important to next generation. Sean, you want to comment on your progress?

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Sean Muldoon, Papa John's International, Inc. - Chief Ingredient Officer [38]

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This is Sean. Thanks for that question. As John mentioned, we've been working hard at the Clean Label initiative probably for about seven or eight years and as a result of that, we think we have the cleanest label of all the national pizza chains.

As John and Steve alluded to earlier, just in 2016 alone we removed the 14 unwanted ingredients that John mentioned. We removed artificial flavors and colors, high fructose corn syrup. We moved to -- we transition to raised without antibiotic chicken and cage free eggs. That was just 2016 alone. We think we keep widening the gap with our major competitors and, yes, I do think that it helps us with our consumer base. I think they reward us over the long term in terms of our consistency of our quality.

As John mentioned, with Millennials, moms with kids, super important in terms of transparency in terms of our ingredients, them understanding where those ingredients come from, that they have short, simple statements, they don't have long chemically sounding words that connotate bad for you. We do think that's a differentiator for us in the best way.

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Peter Saleh, BTIG - Analyst [39]

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Great. My last question, it seems like one of your larger competitors is focusing a lot more on carry out. Is that something you guys are considering, or is there a reason why you guys don't focus a little bit more of your ads on the carry out business?

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John Schnatter, Papa John's International, Inc. - Founder, Chairman and CEO [40]

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Steve, you want to take that one?

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Steve Ritchie, Papa John's International, Inc. - President and COO [41]

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Sure, Peter, it's Steve. I think for us it's important with balance and the amount of dollars that we have to invest. One of our larger players is certainly has got two to three times the amount of marketing dollars to spend, so they can afford to have split message on delivery offers on one side of it and on the side of it, do carry out offers.

Our carry out business as a whole has been very healthy. We really have not seen any shift in our percentage of carry out business over the last 10 years, even with the growth of the online side of the business. With that being said, consumer behaviors continue to evolve and we'll continue to adapt to that. You may see some things that we've done from a testing perspective to appeal to that carry out consumer and you may see some things in the future that we will leverage to ensure that we're taking advantage of those consumer behaviors.

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Peter Saleh, BTIG - Analyst [42]

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All right. Thank you very much.

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Operator [43]

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Alton Stump, Longbow Research.

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Alton Stump, Longbow Research - Analyst [44]

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Good morning, everyone. Talk about pan pizza. Not to harp on it. It's already come up quite a few times, but I think you mentioned, John, it was mixing at 22% of sales, if I heard that right, which is an awfully high number but obviously you had the promotional price point, which I would guess that, that probably having a discount price point might have offset all or most of any benefits of traffic that you guys saw. A, is that true, and then B, how long do you plan on keeping that $10 price point that you have currently on your pan pizza?

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John Schnatter, Papa John's International, Inc. - Founder, Chairman and CEO [45]

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Alton, this is John. I'll take it from a high level and then Steve, you can get into the details. Our largest competitor, who is known for pan pizza, was at $7, very aggressive, and we are at $10. The previous question on quality and clean ingredients and really positioning the brand as a quality leader, it definitely pays dividends. Traffic, the 22% is when you are promoting and of course that drops off somewhat when you don't promote it. But we hit that dead on and traffic in Q4 was up. Steve?

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Steve Ritchie, Papa John's International, Inc. - President and COO [46]

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Sure, John. It is Steve. I think again, Alton, pretty pleased with how the product performed. The factors that I had spoken to before I think were the factors that maybe kept the overall comps from being slightly higher and many of those were intentional on our part, as I alluded to.

In terms of the price promotion, we don't have necessarily a national $10 promotion price out right now, but strategically, because of the value of the pan product, we have aligned directly with our large pizza, so you might see it our large promotion out there right now that we do have $9.99 for a two topping large or pan in addition to we have an LTO product out there right now, our ultimate meats product, that you can also get large or pan for that price point. I think it's $11 price point on our ultimate meats product. That would be the strategy moving forward to try to bring more into the fold by opening up the opportunity, have another crust type at a value then we'll attempt to align that strategically with our large pricing.

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John Schnatter, Papa John's International, Inc. - Founder, Chairman and CEO [47]

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Alton, Steve and the team, Sean and R&D, they worked very hard on this for over a year and-a-half to get this product right. As you know, we have a restaurant in the building so I can watch what the 900 people in the building do every day and get a good idea of whether the product's good or not and I can tell you that the mix in the building is not going down at all. People like this product. If you get the product right and again, the culture and the service, it just works long term.

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Alton Stump, Longbow Research - Analyst [48]

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That's helpful. Thanks, John and Steve. Looking back to the first-of-the-year price point of the two large pizzas for $8, if I'm right, that's a bit less aggressive than buy one get one freeish type of deals that you guys have done for the last couple years of the first of year. If that's true, what was reasoning being a bit less aggressive? Is there an opportunity now, to your point, Steve, that things are a bit slower so far in the first quarter to get a bit more price aggressive going forward?

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Steve Ritchie, Papa John's International, Inc. - President and COO [49]

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Oh, sure, Alton. I'll answer that. The price promotion of the two for $8 versus the bogo in terms of overall ticket average comparison, it's pretty consistent. A regular price large two-topping pizza is pretty close to $16, so it's pretty comparable. It's a way for us to get a price point out there at more of a value to be more appealing, given where some of our competitors have been priced in the deep discounting of selling $5 and $6 pizzas.

Clearly, being a premium brand we've been able to give up slightly higher overall price on the per-pie basis. But as we look at that, there has been some learnings we can apply into what we're doing the rest of the first quarter with the $9.99 two toppings that's out there. If you go to our homepage website now we have got a couple of -- we have some new technology provides us with we call the sidekick. There's two additional offers that we are focused on, one being the $9.99 two top. We're also featuring two mediums, two toppings each, for $6.99.

There is more value that is out to the consumer, especially since we have, again, nearly 60% of our consumers going to that website. We will continue to adapt and evolve if the pricing environment and the consumer demands value will work through our value equation to ensure we continue to grow positive traffic and guide toward that 2% to 4% growth for the full year.

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Alton Stump, Longbow Research - Analyst [50]

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Thanks. One last one and I will hop back in the queue. This one's for Lance. On the insurance cost front, it looks like that's scaled down, obviously had that pop up back in 2015. Any outlook for 2017, whether that could be up or down or flattish versus 2016?

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Lance Tucker, Papa John's International, Inc. - CFO [51]

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Sure, Alton. A couple things I would say there. In the fourth quarter, in our last call we had warned that we were going to have some increases in auto insurance and we did. We took a hit in the fourth quarter on that.

As far as 2017 looks, that is one of several headwinds that we have as we look at 2017 and why those guidance numbers are a little lower. One of them certainly is auto insurance. We have several things that are going to be several pennies each and auto insurance combined with the steps were taken to mitigate that issue is certainly one of those.

I will mention a couple others. Commodities are going to be a little bit up. We've got some labor pressures. We've talked about the higher ad fund rate and the fact that, that's largely going to offset media inflation. We're opening a new QCC in Georgia. Those are a few of the things that are going to cause us to be a little more cautious about 2017 here as we kick off the year, along with the little bit slower start to sales that we expected. Auto insurance is going to be in there. I don't think it's going to be as big as a spend in some past years, Alton, as far as the increment but we've just got to wait and see how that plays out.

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Alton Stump, Longbow Research - Analyst [52]

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Got it. Thank you.

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Operator [53]

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Mark Smith, Feltl and Company.

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Mark Smith, Feltl and Company - Analyst [54]

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First off, this might be for Lance. Can you walk us through your CapEx guidance? What is it being spent on this year? How much is still new commissary and anything else in CapEx?

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Lance Tucker, Papa John's International, Inc. - CFO [55]

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Sure, Mark. We don't give the exact details so I'm going to be high level on this. Typically we spent directionally a little bit over a third on technology, close to a third on restaurants, and by that I'm really meaning making sure that we are doing all the proper maintenance and reloads and models and things we need to keep the restaurants looking good. That last third falls into a bucket between what we're doing with QCCs as well as some marketing investments.

As you look at 2016, we were a bit higher, coming in at $55 million. That was because mainly driven by QCC in Georgia. As you look to 2017, the QCC number is still going to be higher than has been in past years. It will not be as high as it was in 2016 relative to that Georgia QCC. So overall, you'll see our guidance at $45 million to $55 million is a little bit less than we have guided in the prior year. That is because George QCC will still have some investment but it will be less than last year.

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Mark Smith, Feltl and Company - Analyst [56]

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Is there any updates on the Company units in China, kind of how that sales process is going and then in line with that, could you give us update on outlook for you international market, international sales, any areas that are doing well or maybe that are not doing so well?

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John Schnatter, Papa John's International, Inc. - Founder, Chairman and CEO [57]

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Lance, why don't you answer the question on China and then Steve, you can give an overview of the entire international.

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Lance Tucker, Papa John's International, Inc. - CFO [58]

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Absolutely. Mark, this is Lance. On the China piece, we do continue to pursue the divestiture. We're actually making very good progress on that. Clearly it's taking a little longer than we would've liked, but we feel like we're on the right track and certainly when a transaction has been completed, we will let you all know. Steve, on the rest of international?

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Steve Ritchie, Papa John's International, Inc. - President and COO [59]

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Sure, Mark, and thanks for the question. This is an area, as I commented on my prepared remarks, that generates the most excitement for the brand. If you're a long-term holder, this is why you should be keenly interested in the Papa John's brand.

Our international business is performing overall quite well. As you can see, our full-year comps last year, 6%. The majority of our regions were contributors to that 6% comp. The majority of our regions were over the 6% comp.

Latin America had a great year, building off of a great year the previous year, so we feel really good about the overall region in each market within Latin America and the opportunity for future growth. We are not in the country of Brazil at this stage of the game, so that is clearly one country that we look at in that region based on the success that we've had within the Latin American region.

You move over to Europe, and I'll throw UK into that. That business has been on fire over the last couple of years, so the UK business doing quite well. Our business throughout Europe, Russia where we're heavily penetrated in terms of number of units, but our six new countries are predominately focused in the European region, as we've opened stores in France and Spain, the Netherlands, those stores are coming out of the gates really strong and we have a long runway in terms of additional units. Our Chief Development Officer, Tim O'Hern, spends a predominate amount of his time talking about the future of our international business and I can tell you he's quite optimistic about the future within that region of the world.

We're more heavily penetrated and filled and saturated is within the Middle East, but our stores continue to have great same-store sales growth and profitability and they continue to look for opportunities for additional development even outside of those regions. We have just started to move into Northern Africa region, so that is an area of opportunity. Then eventually we'll take a look at South Africa. It's probably the more sizable opportunity within that continent.

We have not gone into Australia yet, but we're not afraid to go into Australia. As we continue to have success in these other regions, that's an area where we'll take a hard look at.

The Southeast Asian region, as we've said before, continues to be a challenge, but we're pretty optimistic once we get the China transaction completed that, that provides us an opportunity to bring in the new thought leadership and help us get that region moving forward because if that region starts performing at near-average levels, our overall same-store sales will increase higher than what we've performed over the last several years.

Last thing I would note is that we have 1,400 stores and growing in the development pipeline and as we bring on new countries and we expand development agreements in these opportunities, that gives the opportunity to really accelerate growth on the international side. Now over 80% rate or right about 80% of our overall growth, as we guided to 4% to 5%, so we expect to see incremental units 2017 versus 2016 and the predominant amount of those are coming from international side.

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Mark Smith, Feltl and Company - Analyst [60]

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Great. Thank you.

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Operator [61]

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Chris O'Cull, KeyBanc.

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Chris O'Cull, KeyBanc Capital Markets - Analyst [62]

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Lance, you mentioned in the release that the earnings outlook does not assume the adoption or, I guess, the impact of the new accounting standard for stock compensation expense, but it looks like it would have a pretty meaningful benefit to earnings per share. Why not include at least some of the benefit of a lower tax rate into the guidance? I guess also can give us any color as to which quarter do executive RSUs vest and how potentially it could impact the year?

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John Schnatter, Papa John's International, Inc. - Founder, Chairman and CEO [63]

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Lance, before you take the question, Chris, just to give you an overview, last year this time, February of 2016, we gave our EPS guidance of 13% to 18% and we came in at 22%. It's kind of our nature to be a little more conservative at the beginning of the year, especially with a little bit of a soft start. Lance?

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Lance Tucker, Papa John's International, Inc. - CFO [64]

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Sure, Chris. I will hit the tax piece and that's a good question. First of all, just to make sure, I think everybody on the call is aware of what the rules are, but let me just run through that real quick. The new rules require you to recognise any additional tax benefit or tax charge you receive when stock options are exercised, also when restricted shares vest in your P&L. The old rule, it went through your equity, your equity statement. Now it's going to be going through your P&L.

The first thing I would stress is there's no cash or economic impact. It's all just presentation. The reason that we didn't attempt to build into our earnings at this point, Chris, is because it's going to create a lot of volatility, particularly for a company like us that has significant gains or value in our stock options. If you look back historically, we went back five or six years, it could impact our EPS based on prior years anywhere from a few pennies to literally $0.25. Certainly we could take a swag, and I'm not going to give you this number, we could take a swag at what might be that but requires us to predict what's the stock price going to be and what kind of stock options exercises will come at that particular stock price.

What we prefer to do and what we're going to do is give you the numbers without it and then we will tell you what the number is with it as we have significant impacts to our tax rate as we go. Because otherwise it would expand the guidance range to 10% of earnings growth and that just, to me, that's less meaningful than doing it this way. As far as timing, a lot of it has to do when things are going to hit and when people actually exercise options and we have things that vest at various times in the year, so I'm not going to attempt to tell you it's going to be higher in Q1 versus Q3 or 4 or 2.

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Chris O'Cull, KeyBanc Capital Markets - Analyst [65]

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Okay. No, that's fair. That's very helpful. Thank you.

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Operator [66]

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Peter Saleh, BTIG.

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Peter Saleh, BTIG - Analyst [67]

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Great. Thanks for taking the question. Last year at this time I think we were in a highly promotional environment as well and you guys seem to be able to snap out of it and reaccelerate the overall comps. Can you remind us again what exactly happened last year, what changed on your marketing schedule that allowed the comps to bend and turn the other way and where you guys are in the process, I guess, of adjusting the marketing schedule?

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John Schnatter, Papa John's International, Inc. - Founder, Chairman and CEO [68]

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Peter, this is John. I will give you a high view and then Steve, you can give the details. I've been doing this for 41 years. We been doing Papa John's for 32. We know this business and we know what levers to pull to make the business go up.

Every morning at 8.59 we're on a call with 60 of the folks out in the field talking about what happened last night and what's going to happen today. We do this every day. If sales were high, we kind of go, what happened? If sales are a little bit soft, we go, what can we do to rectify it? This is something that we've been dealing with. The business will have ups and downs. When it is up, it's great, and when it's slightly down, you've got to pull some levers.

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Steve Ritchie, Papa John's International, Inc. - President and COO [69]

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Peter, it's Steve. I will comment on a couple of things. I think John hit it pretty good because that's how we look at the business, always looking big picture but getting down to the tactical efforts on a daily basis to understand the factors that are moving the sales.

Last year the, similar to this year, extremely competitive environment, heavy, heavy spend. We're seeing more spend and more activity this year versus last year. All three of our largest players are out there on, as I had stated before, $5 and $6 kind of promotions. Last year we made some tweaks to our promotion where was an online-only promotion at our $9.99 up to five toppings. We opened that up more broadly to on- and off-line business and made we some incremental investments to ensure that we were getting the share of voice necessary.

Not too dissimilar to this year, where share of voice has been a challenge when you've got heavy, heavy media spend and more aggressive price promotions. We will pull the levers necessary to ensure that our price and promotion and our share of voice is out to move the business in the right direction. Clearly we have some plans in place currently for the duration of the first quarter and more specifically a number of things that we've got in motion that drive the confidence on the full year.

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John Schnatter, Papa John's International, Inc. - Founder, Chairman and CEO [70]

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Peter, we have not been negative for 13 years and we don't have any plans on being negative anytime soon. When it is soft we're on it and when it is doing well, then we enjoy it.

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Peter Saleh, BTIG - Analyst [71]

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Great. Thank you very much.

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Operator [72]

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I'm not showing any further questions at this time. I'd like to turn the call back over to Lance Tucker.

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Lance Tucker, Papa John's International, Inc. - CFO [73]

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Thank you, Kevin, and thanks, everybody, for being on the call. We appreciate your time and we will talk to you when we announce our first-quarter earnings in early May. Thank you.

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Operator [74]

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Ladies and gentlemen, this does conclude today's presentation. You may now disconnect and have a wonderful day.