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Edited Transcript of PZZA earnings conference call or presentation 3-May-17 2:00pm GMT

Thomson Reuters StreetEvents

Q1 2017 Papa John's International Inc Earnings Call

LOUISVILLE May 5, 2017 (Thomson StreetEvents) -- Edited Transcript of Papa John's International Inc earnings conference call or presentation Wednesday, May 3, 2017 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* John H. Schnatter

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

* Lance F. Tucker

Papa John's International, Inc. - CFO, Chief Administrative Officer, SVP and Treasurer

* Mike Nettles

Papa John's International, Inc. - Chief Information & Digital Officer and SVP

* Steve M. Ritchie

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

* Timothy C. O'Hern

Papa John's International, Inc. - Chief Development Officer and SVP

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Conference Call Participants

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* Alexander Russell Slagle

Jefferies LLC, Research Division - Equity Analyst

* Alton Kemp Stump

Longbow Research LLC - Senior Research Analyst

* Christopher Thomas O'Cull

KeyBanc Capital Markets Inc., Research Division - Director and Equity Research Analyst

* Mark Eric Smith

Feltl and Company, Inc., Research Division - Senior Research Analyst

* Peter Mokhlis Saleh

BTIG, LLC, Research Division - MD and Senior Restaurant Analyst

* Will Slabaugh

Stephens Inc., Research Division - MD

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to the Papa John's First Quarter 2017 Conference Call and Webcast. (Operator Instructions) As a reminder, today's conference is being recorded. I would now like to turn the call over to Mr. Lance Tucker, CFO. Sir, you may begin.

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Lance F. Tucker, Papa John's International, Inc. - CFO, Chief Administrative Officer, SVP and Treasurer [2]

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Thank you, Chelsea, and good morning, everyone. Joining me on the call today are our Founder, Chairman and CEO, John Schnatter; our President and COO, Steve Ritchie; and 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, involving risks 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 press release and the risk factors included in our SEC filings.

Please refer to our earnings release in the Investor Relations section of our website for a reconciliation of non-GAAP financial measures discussed on this call.

Now onto a discussion of our first quarter operating results.

Diluted EPS in the first quarter was $0.77, up 12% over 2016. EPS benefited by $0.03 due to the adoption of the new stock-based accounting rules.

First quarter revenues were up 4.8%, driven primarily by higher QCC sales from volume increases and higher commodity prices as well as increased global comp sales and units.

Domestic company-owned restaurant margins decreased to 1.6%, driven primarily by higher labor, higher non-owned automobile claim costs and increased mileage reimbursement expense from higher fuel prices.

North America commissary and other margins decreased 50 basis points, due primarily to the higher delivery expense of the commissaries, offset partially by improved margins from our online and mobile ordering business.

International margins improved 1%, due primarily to an increase in franchise royalties from 6% comps and the year-over-year increase in units. G&A was lower by approximately $2.2 million, down to 8.5% of consolidated revenues due to several factors, including lower franchise incentives, lower bonuses, favorable bad debt experience and the timing of international marketing spend.

Our effective tax rate was 28.6% in the first quarter, down 3.7% from the prior year. Of this decrease, 3.2% was due to the new stock-based compensation accounting rules.

We repurchased $13 million of stock during the quarter and currently have approximately $120 million of remaining share repurchase authorization. And our free cash flow, a non-GAAP measure, we define as cash flow from operations less capital expenditures, was approximately $32.3 million in the first quarter, up from 2016, mainly due to a large nonrecurring payment that occurred in 2016.

As noted in our previous press release, the company is reaffirming all aspects of its previously issued 2017 outlook. To reiterate, our EPS outlook includes the benefit of the 53rd week and excludes the impact of the new stock-based compensation accounting rules.

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

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John H. 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 on the call today as we discuss our first quarter 2017 results.

I am pleased with our solid revenue and earnings growth in the first quarter. We continued to perform well in a challenging environment and expect 2017 to be another good year of growth for Papa John's global brand. Our continued success comes from our strong fundamentals, as we continue to build upon our commitment of "Better Ingredients. Better Pizza" and having the cleanest label among national pizza brands. As part of that clean label and better ingredient journey, we recently launched 2 separate menu pilot programs. First, we debuted organic vegetable toppings in our pizzas across the Lexington market. The test includes freshly sliced Roma tomatoes, green peppers, yellow onions and mushrooms, and we've been receiving great feedback from our customers. This is an important step in offering better options to consumers in driving our business as more than half of American household purchase organic produce. We will continue to lead the way in creating positive change for the pizza category and in our food system, working with our suppliers like Green BEAN Delivery.

Additionally, we also recently announced the pilot program for our gluten-free crust made with ancient grains. The Papa John's R&D team, that does a fantastic job, led by Chief Ingredient Officer, Sean Muldoon, spent more than a year to develop this product with the goal of offering pizza fans a better tasting, gluten-free pizza crust. I think they delivered. Not only does it taste better, the ancient grains are naturally gluten-free and higher in protein and fiber than other grains. This new crust is currently being tested in Papa John's locations across Los Angeles, Phoenix, St. Louis, Houston and Nashville.

Speaking of new additions. Our sports partnerships continue to perform extremely strong for us. In February, we named -- we were named official pizza partner of the NHRA. We remain the only QSR in the sport and sponsored the NHRA's top driver, DSR's Leah Pritchett, who has won 3 out of the first 6 races of the season and set a world speed record. We also announced the charity challenge series. We're always looking for ways to give back to local communities. And throughout the 2017 NHRA season, we will be supporting in raising awareness for Infinite Hero Foundation. The foundation promotes awareness and provides resources to help combat the mental and physical issues that returning military heroes and their families have to deal with. I'm proud of the work with [Liam], a valued member of the Papa John's family, to help shine a light on the great work they do to benefit the military heroes and their families. I'm also happy that my Z28 Camaro is still positively having an impact on lives, especially our military.

To conclude, I'm pleased to get 2017 off to a solid start.

With that, I'll turn it over to Steve Ritchie. Steve?

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

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All right. Thank you, John, and good morning, everyone. Thanks for joining us on the call today as we discuss our first quarter 2017 results.

I'm very proud of our franchisees and operators for continuing to provide exceptional service and quality to our customers across the globe, maintaining our position as the recognized leader in quality within the industry. As always, we maintain our commitment to deliver superior customer experiences, amplified by our team-member-first approach. As John stated, our relentless focus on high-quality clean label ingredients, operational execution of the fundamentals and giving back to our local communities are just some of the key factors that continue to differentiate our brand. Our consistent commitment to our core values delivered our 26th consecutive quarter of positive comp sales growth. Our domestic restaurants continue to produce positive sales growth in this ever-evolving consumer environment. Restaurant margins were negatively impacted in the quarter by wage inflation, higher cheese costs and delivery-related headwinds. But despite the Q1 headwinds, we are confident in our reaffirmed full year 2017 comparable sales and earnings guidance as well as our long-term growth potential.

Moving to international. We've now reached over 1,600 locations in 45 countries and territories. We see a significant opportunity for growth abroad and continued our great momentum on this front in Q1 with improved sales, margins and profits. Q1 marked our 29th consecutive quarter of positive comp sales growth for our international business. In March, we announced the opening of our 100th location in Russia, one of our strongest international markets, as well as the opening of our second market in Northern Africa in Casablanca, Morocco.

Speaking of expansion. Our sports partnerships continue to perform strongly for us. In late March, we announced the start of our second year as the official pizza of Major League Baseball and we'll extend our successful PAPASLAM promotion where pizza fans receive 40% off regular menu price pizzas the day after a grand slam is hit. This was a great sales driver for us last season, and we expect the same this season.

On the technology front, we continue to reinforce our commitment to providing a better customer experience with enhancements to our digital ordering process. We averaged over 60% domestic sales across our digital channels in Q1, of which roughly 70% is from our mobile ordering channels. In addition to being the leader in digital payment options at check out, in March, we announced the introduction of Papa Track, a digital pizza tracker that allows customers to follow the pizza process from the oven to delivery. Just as we do with our ingredients, we prioritize and invested in additional digital payment options and the development of Papa Track to provide customers with a seamless experience, from ordering and paying for their pizza, to tracking that order, to delivery.

To conclude, we are happy to report consumers are recognizing our unwavering commitment to quality and our efforts to improve the customer experience. Papa John's is taking its place as the 2017 Pizza Brand of the Year in the 2017 Harris Poll EquiTrend rate rankings. The poll measures brand perceptions of more than 100,000 U.S. consumers across more than 4,000 brands, from automobiles, to TVs and technology. We are proud to be recognized as the pizza category leader by consumers and confident that we have the brand strength to continue producing great results for years to come.

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

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Lance F. Tucker, Papa John's International, Inc. - CFO, Chief Administrative Officer, SVP and Treasurer [5]

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Thank you. Chelsea, we are ready for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question comes from the line of Alton Stump with Longbow Research.

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Alton Kemp Stump, Longbow Research LLC - Senior Research Analyst [2]

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I know you don't like to talk about intra-quarter comps, but if I go back to your comments on the fourth quarter conference call, as the trends to date at that point in the first quarter, it appears that comps picked up a little bit in the back half of the first quarter. Is that true and sort of what drove that? And then if you could give us any kind of color commentary on how things are trending so far here in 2Q?

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Steve M. Ritchie, Papa John's International, Inc. - President and COO [3]

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Sure Alton, it's Steve. I'll take that one. Thanks for the question. As I alluded to on the last call to your point, we did come out of the gates a little softer than what we had planned for. We are pleased with the overall 2% comp that we produced within the quarter. To your question of cadences, we typically don't like to get into cadence. What I would say is, to your question, we did get a little bit better just in terms of the transaction improvements that we saw coming out of the quarter in March. Some of that's attributed to some slightly more aggressive promotions that we did the last couple of weeks of the quarter from a national perspective. We implemented our customer appreciation week for the last couple of weeks of the quarter. But overall, pleased with the quarter. And to your question of how are things going now, I guess what I would lead to is that, you think about our full year guidance of 2% to 4%, we feel very confident, and we talked about in our opening remarks that we will be well within our full year guidance of 2% to 4%.

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Alton Kemp Stump, Longbow Research LLC - Senior Research Analyst [4]

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That's helpful. And then was there any impacts from Easter as to a shift there in the quarter?

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Steve M. Ritchie, Papa John's International, Inc. - President and COO [5]

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I'm sorry, Alton, what was your question again?

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Alton Kemp Stump, Longbow Research LLC - Senior Research Analyst [6]

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Yes. I asked if there's any impact from the Easter shift.

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Steve M. Ritchie, Papa John's International, Inc. - President and COO [7]

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For the Easter shift? Okay. Sorry about that, I didn't hear your question at first. Not a material impact. Certainly, it's a slight little benefit, not really material within the quarter. And obviously, the shift to P4 in Q2, the same thing, we don't really expect a material improvement.

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Alton Kemp Stump, Longbow Research LLC - Senior Research Analyst [8]

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Got it. And then just one follow-up and then I'll hop back in queue. But just on your growth front, obviously, first quarter, running a little bit lower, and you guys sort of -- what gives you confidence that you can get the annual guidance for the full year? And then, if you can maybe just touch on the 30 store closures in North America through -- what drove that?

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Steve M. Ritchie, Papa John's International, Inc. - President and COO [9]

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Sure, Alton. It's Steve again. I'd say, similar to what last year looked like in '16, in the first quarter, we came out of the gates a little softer. The category has been consistently really aggressive just in terms of pricing, promotional activity and media spend across the category from our competitors. So I would say, if you look at the trailing quarters last several years, if you look at stacks, that's what gives us really the confidence. And some of this is cyclical in nature. From an initiative standpoint, we look at our marketing promotional calendar that we have planned, as I alluded to, the Major League Baseball, the second year buildup from that, the things that we have in place and planned for our partnership, our new partnership with NHRA over the summer, and then kicking off the NFL as we kick off that in period 9 through the end of the year. So certainly, if you look at the promotional plans that we have in the year, we're really taking a step up against what we did last year, and that drives us again to kind of fall into that 2% to 4%, which will produce kind of a 3.5% to 5.5% 2 year stack. As it alludes to your question to the closures, really a function of timing. We talked about this on the last call that the predominant amount of our openings are going to occur in the back half of 2017. From a timing standpoint, we also had an increase in those closures that did occur in Q1 where some of our anticipation that will be spread out a little bit more into Q2. I would highlight that there is -- it's predominantly in a couple of regions and some of that is strategic in nature. The first would be in the Northeast where we had -- we just had a slight pick-up in closures in a couple of underpenetrated markets. But from a strategic standpoint, some clean-up in China, on the franchise side in South and East China within our franchisees. So the majority of the -- the vast majority of the closures did occur there. I highlight it strategically because we're starting to see some real pickup from a sales momentum perspective with our franchisee in China, which gives us a lot of optimism on the long-term potential of our China business. The last thing I would just say is that we're well within that 4% to 5% full year guidance still on the development front.

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Operator [10]

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And our next question comes from the line of Alex Slagle with Jefferies.

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Alexander Russell Slagle, Jefferies LLC, Research Division - Equity Analyst [11]

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I wanted to follow up on development, because you've announced a number of new development agreements, entered a bunch of new countries, so would just like to get an idea of how we should think about the potential ramp in growth over the next couple of years? And if there's a certain point where we'll reach an inflection and see those openings really accelerate?

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Timothy C. O'Hern, Papa John's International, Inc. - Chief Development Officer and SVP [12]

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This is Tim O'Hern, the Chief Development Officer. We feel really strong about our international ramp and where it's headed. We have a very robust pipeline in terms of units in the queue to be developed. We really like where we're headed with our development in Northern Africa. Tunisia, Morocco, Egypt have been very strong for us. We like what we've seen out of our development in Europe. Our Russian franchisee continues to grow that market and is pursuing additional markets within the former Soviet states. We're really happy with that. We've had some struggles in China, frankly, but we've gotten turned around in one of the markets and are focusing on the other. So we're happy with that. But all in all, our pipeline is very robust, very strong. We have a number of groups we're working with to develop other countries. And our lead generation continues to be strong.

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

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Yes. Thank you, Tim. And Alex, the only thing I would add is that we as talked about on the last call, we had a record number of new country openings, and Tim hit some of those. And we anticipate to have new countries again this year. I don't know that it will hit record, but the buildup of that does take a little bit of time. So the first couple of years, you'll see minimal units. But as we expand in those units, the scale will provide the growth. And obviously, the guidance indicates coming off last year's 204 unit openings, our range indicates that we're going to see nice growth from a development perspective in 2017.

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Alexander Russell Slagle, Jefferies LLC, Research Division - Equity Analyst [14]

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Okay. And then, Lance, on the corporate cost of goods, it was slightly lower year-over-year. And I imagine you're still seeing some benefits from favorable cheese contracts and perhaps lower meat and dough costs. But I think you previously talked about potentially seeing the cost of goods as a percentage of revenue up 50 to 150 basis points this year due to the cheese costs. Should we still look for that kind of increase?

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Lance F. Tucker, Papa John's International, Inc. - CFO, Chief Administrative Officer, SVP and Treasurer [15]

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I think given that cheese has come down a little bit relative to where we thought it we'd be, we're more in the 50 to 100 basis points, so we're going to take the top end of that range down a little bit for right now. And you're right. Relative to the first quarter, we got some benefit from the forward pricing arrangements we had done, and really were able to keep the cheese increase very well in check in Q1.

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Operator [16]

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And our next question comes from the line of Will Slabaugh with Stephens Inc.

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Will Slabaugh, Stephens Inc., Research Division - MD [17]

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First question on the commissary. That number looked a little higher than where we thought it was going to be. It looks like that growth was up around 10% this quarter. I think 12% or so was the growth last quarter. And I'm wondering what's driving that. And how we should think about that growth rate in the coming quarters?

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Lance F. Tucker, Papa John's International, Inc. - CFO, Chief Administrative Officer, SVP and Treasurer [18]

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Sure. And Will, I assume you're talking about the revenue number, correct?

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Will Slabaugh, Stephens Inc., Research Division - MD [19]

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Correct.

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Lance F. Tucker, Papa John's International, Inc. - CFO, Chief Administrative Officer, SVP and Treasurer [20]

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All right. So we have a fixed penny margin on our cheese, which is the biggest single item that the commissary sales. It's about 30% to 35% of the cost of a pizza. So when you see the price of cheese go up, and it was up about $0.14 on the block in the first quarter, what you're going to see is you're going to see the gross revenue number go up, the dollar margin doesn't change, so the percentage margin actually comes down a little bit. But that's what drove that increase. Of the $17 million or so, the big piece of it was, in fact, the cheese increase. There was also an increase in pizzas though.

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Will Slabaugh, Stephens Inc., Research Division - MD [21]

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Got you. That's helpful. On the G&A side, that came down pretty nicely. And I'm curious where that flexibility came from in the quarter. And as you think about G&A for the year, if that changes much of the outlook for how we think about the remaining quarters.

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Lance F. Tucker, Papa John's International, Inc. - CFO, Chief Administrative Officer, SVP and Treasurer [22]

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Sure. So during the quarter, a couple of the things that are mentioned in the Q, and that I mentioned in my script, we did have a little bit lower incentive costs. Some of our bonuses were down, which we really don't necessarily want to see, frankly. And we had favorable bad debt experience. And then we did have a little bit of timing from some marketing spend in the United Kingdom that runs through our G&A. For the full year, what I would expect is we're going to be priced slightly down as a percentage. You should see some leverage on the revenue -- against the revenue line, so we'll be down as a percent versus last year. I'm not going to put a number on it, but I would say a little bit.

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Will Slabaugh, Stephens Inc., Research Division - MD [23]

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Great. And the last thing I had was on the tax rate. You mentioned the benefit you had this quarter. I'm curious if the guidance now includes the benefit going forward or not.

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Lance F. Tucker, Papa John's International, Inc. - CFO, Chief Administrative Officer, SVP and Treasurer [24]

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No. I'm glad you asked that question. There were -- there have been several reports out there that were kind of asking that question. So I reiterated this at the end of my scripted remarks and I'll say it again. Guidance is 8% to 12%. It includes the 53rd week, but it excludes the impact from the stock comp guidance. So what you should see -- certainly, the stock comp accounting is going to be positive for us. Though at a minimum, what I would tell you is you wouldn't see the guidance come down, at least not due to stock comp.

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Operator [25]

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And our next question comes from the line of Peter Saleh with BTIG.

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Peter Mokhlis Saleh, BTIG, LLC, Research Division - MD and Senior Restaurant Analyst [26]

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I wanted to ask about the overall promotional environment and maybe what you guys are seeing today versus what you saw over the past couple of months. And just give us a little bit of history lesson as well. I'm just wondering, has the promotional environment, in your opinion, has it subsided at all on the discounting side? And historically, is it more aggressive in the first quarter than it is in the second and third quarter?

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Steve M. Ritchie, Papa John's International, Inc. - President and COO [27]

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Peter, it's Steve. Good question. I would say, just overall, just to hit the first part of your question. The competitive environment's really remained pretty consistent in 2017 versus where we were in 2016 across the category. It's just if you think about pricing for Papa John's, pricing is a tactical element of what we do. Some other brands will use pricing as more of a strategy and is really their brand positioning clearly. Our brand position is on quality. We will leverage pricing to be competitive and ensure that we continue to take and grow share within the U.S. business. But it's not our brand positioning. To your question on the first quarter, yes, it has historically, at least over the last 3 to 4 years, been extremely more aggressive in the first quarter than the trailing 3 quarters. However, the environment is ever evolving. And if performance is down or commodity costs decrease from time to time, you'll see a tendency to -- see the competitors get -- have windows of more aggressiveness throughout the year, but we have our plans in place to be able to react to that, and we do pick our spots where we might get a little bit more aggressive. The digital side of the business is clearly an area where we're going to continue to play and make sure that we're being very targeted with our segments. And in fact, I might turn it over to Mike Nettles just to make some comments of where we're at in the digital space, our new Chief Information and Digital Officer. Mike?

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Mike Nettles, Papa John's International, Inc. - Chief Information & Digital Officer and SVP [28]

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Thank you, Steve. So I think a big part of what we have an opportunity for, and you're going to see a lot more of this, is tying our digital marketing into the rest of our digital property. So we've got a tremendous opportunity to leverage unique meal experiences. If you're watching an NFL game and we're -- have a deep integrated sponsorship with the NFL, we can tie that into halftime promotions, make sure that the customer is well aware that when they're hungry and they're thinking of snacks for their parties, that they're able to get those quickly. We present them to them as opportunities ahead of the game, so they're not actually waiting on it. Use Papa Track to actually tell them that, hey, it's going to be there in time for halftime, and kind of run with those type of programs wherever possible. I think we have many other opportunities. You're going to see this year where we're going to be continuing to tie that digital outreach, particularly through our social media channels, where we get the opportunity to really connect with customers more in a targeted demographic segment as opposed to kind of broad-brush the entire industry. So more to come on that. And don't necessarily want to reveal all the things we're doing, but you're going to see a lot of those themes repeating themselves over the course of the next several quarters.

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Peter Mokhlis Saleh, BTIG, LLC, Research Division - MD and Senior Restaurant Analyst [29]

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Great. And then I just wanted to come back to the, I guess, using price as a lever comment. I mean when we look at your comps in the first quarter, how should we think about -- I know you want to give us exact numbers, but your ticket versus your traffic components of getting to that 2% number in the U.S.?

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Steve M. Ritchie, Papa John's International, Inc. - President and COO [30]

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Yes, Peter. It's Steve. And yes, clearly, we don't give specifics on our traffic versus our ticket, but what I will say is the last 5 years, we've had traffic growth, and we don't intend to move off of that for our full year in 2017. It is a delicate balance from a promotional window to promotional window. And to Mike's point on how we leverage the digital side of the business to drive the overall sales component and how that might impact on the traffic side. But we're going to remain focused on traffic because for our brands, it's all about market share growth in a very fragmented category where the national chain still have less than half of the overall share. So we know that we need to remain competitive and have good balanced pricing strategy, but leveraging the strength of our brand positioning, as I alluded to before, pricing for us is not a strategy. It is a tactical element on how we drive the overall business.

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John H. Schnatter, Papa John's International, Inc. - Founder, Chairman and CEO [31]

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Yes, Peter, this is John. If you look at it from 40,000 feet the category, Papa Murphy's is losing, Pizza Hut is losing big, Domino's frankly is on fire, and Papa John's is just solid. It's just very consistent performing, and that's the big picture of this thing.

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Peter Mokhlis Saleh, BTIG, LLC, Research Division - MD and Senior Restaurant Analyst [32]

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Great. And then the last question I had is on the sports partnerships. I think last quarter or a few months ago, we were talking about maybe how the NFL partnership was maybe a little bit less relevant in the fourth quarter than it had been in prior years. Now we're talking about the Major League Baseball partnerships and other partnerships. Can you just talk about how relevant some of these partnerships still are and your confidence in them to driving results going forward?

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Steve M. Ritchie, Papa John's International, Inc. - President and COO [33]

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Sure, Peter. It's Steve. And not necessarily to your question around relevance. We do believe the NFL, the Major League Baseball, the NHRA, all of our team partnerships remain relevant, and were relevant in the fourth quarter and continued to be in the first quarter. Just the evolution of what's happening from a watch -- from a frequency and reach standpoint on television, to moving to digital. So there was a decline in the overall ratings with the NFL is what we talked about a little bit in the first quarter. We do spend still a significant amount of our media investment in television and a significant portion of that television media investment is in the NFL. So when the ratings are down, that impacts a little bit of our reach on that side. But as we think about the 2017 season, in fact, the folks with the NFL were in just a couple of short weeks ago and they're very optimistic about their plans for the 2017 season and how we're going to integrate into the NFL and take advantage of those opportunities. So we're still feeling really good about our play just in terms of league partnerships, the individual team partnerships. They are relevant and they're part -- a component of our positioning, but our #1 positioning and key differentiator is quality, and the quality of our ingredients, and that has been that way for the last 33 years, and frankly, will always be the key differentiator. The sports is more the vehicle to deliver that message.

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Operator [34]

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And our next question comes from the line of Chris O'Cull with Keybanc.

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Christopher Thomas O'Cull, KeyBanc Capital Markets Inc., Research Division - Director and Equity Research Analyst [35]

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Lance, store profits were down year-over-year with the 2% comp. So what comp do you think is needed to keep store profit dollars flat?

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Lance F. Tucker, Papa John's International, Inc. - CFO, Chief Administrative Officer, SVP and Treasurer [36]

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Yes. Chris, your question is really going to margins, so let me start with that. I'm not going to give you an exact comp that it takes, because, frankly, it kind of varies by quarter and what else is going on. I will tell you, our restaurant margins were down a little bit over 1.5%, as we've mentioned in our filings, a little bit in the script, you did have a little higher wage, it weights with minimum wage, you had higher non-owned auto claims cost, which has been a recurring theme, as you're aware, had some mileage increases due to fuel. I think the thing I would point out, we're not going to give specific guidance on restaurant margins, as you can imagine, but we certainly don't expect our full year margin to be off or be significantly off in the way of the 20% or so we ran both for the full years in 2015 and '16, so I'm not saying it's going to look exactly like those years, but we don't expect to see really anything near the decline we saw in Q1. One of the things about Q1 is that Q1 '16 had a very strong margin. It had very low commodities, as you'll recall. And it also had or did not have any of the insurance chargers we've seen in some of the other quarters. So in comparison, it suffers a little bit for that reason. So Chris, I don't think the comp really that we need to run is any different than it's been in the past. I just think the margins look a little bit funny given really some of the things that were happening last year at this time.

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Christopher Thomas O'Cull, KeyBanc Capital Markets Inc., Research Division - Director and Equity Research Analyst [37]

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Were franchise profits down year-over-year in the first quarter?

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Steve M. Ritchie, Papa John's International, Inc. - President and COO [38]

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Chris, it's Steve. And I think you're probably going to see something fairly similar to the corporate performance. The comp spread was a little bit different. I think they ran 17, we ran at 3. But just in terms of margin disparity from where the corporate restaurants were, I'd say it's probably rather consistent.

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Christopher Thomas O'Cull, KeyBanc Capital Markets Inc., Research Division - Director and Equity Research Analyst [39]

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Steve, is it fair to assume that franchisees could be at the low end of the comp range given their recent underperformance?

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Steve M. Ritchie, Papa John's International, Inc. - President and COO [40]

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Well, I mean I think if you look at the historical results that we've reported over the last several years, our corporate restaurants have outpaced the franchisees, and we certainly don't -- wouldn't give you any indication that that's going to change in 2017. The spread, however, has decreased over the last couple of years. So corporate's probably going to outperform franchisees again in '17.

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Christopher Thomas O'Cull, KeyBanc Capital Markets Inc., Research Division - Director and Equity Research Analyst [41]

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Okay. Just trying to understand the unit development and then some of the closures that occurred in the quarter, and I mean the comps have been positive. You've got some favorable cheese prices now. And -- but I mean you would think franchisees would be more inclined to the opening stores. Has the discounts and then the discount environment, promotional environment, has that deterred franchisees from wanting to open more stores? And I'm talking domestic.

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Steve M. Ritchie, Papa John's International, Inc. - President and COO [42]

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Yes. Chris, it's Steve again. No, it has not. We still got aggressive openings. And there's still a -- as Tim alluded to before, a strong pipeline, and there is -- heavy on the inquiry side of interest in the Papa John's brand. The closure side, as I alluded to before, of the 30 closures in the domestic side of the business, nearly 70% of them were in a couple of concentrated markets where we still got underpenetration in terms of number of units. The AUVs in those markets are still rather low. And we've also had some more significant wage pressure in those markets in addition to the occupancy costs being higher in those individual markets. I pointed out the Northeast. So it's an area where there's a lot of opportunity for the Papa John's brand, but trying to find the right franchisees to move that business forward is really the focus that Edmond and his team are doing there. But again, at the end of the day, it was more of a function of the timing in the number of closures that occurred in the first quarter. So we certainly don't think that we'll see that kind of a trend on the full year. And I'll just keep going back to the full year guidance and we incorporated a lot of this thinking into our development goals, in the 4% to 5%. So 204 to 250 something, Lance, help me on the number side, I think it's 240 to 255 on that 4% to 5% based on the basis of number of units we had at the end of the year.

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Christopher Thomas O'Cull, KeyBanc Capital Markets Inc., Research Division - Director and Equity Research Analyst [43]

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Okay, fair enough. And then, lastly, just, Lance, why did online order -- the online ordering business margin improve during the quarter?

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Lance F. Tucker, Papa John's International, Inc. - CFO, Chief Administrative Officer, SVP and Treasurer [44]

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Chris, more than anything else, it's just the increased volume. You saw us go up -- actually, we slightly exceeded 60% on the full year -- on a full quarter basis rather for the online business. So it's just a matter of margins going up and leveraging the fixed costs that we have on that side of the business.

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Christopher Thomas O'Cull, KeyBanc Capital Markets Inc., Research Division - Director and Equity Research Analyst [45]

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No pricing changes to the franchisees?

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Lance F. Tucker, Papa John's International, Inc. - CFO, Chief Administrative Officer, SVP and Treasurer [46]

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No.

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Operator [47]

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(Operator Instructions) And our next question comes from the line of Mark Smith with Feltl and Company.

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Mark Eric Smith, Feltl and Company, Inc., Research Division - Senior Research Analyst [48]

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Most of my questions have been answered. But just wondered to see if you can speak to the digital, as that continues to grow. Do you see some regional or even natural versus real differences in how many people are using digital for ordering? And does that give an indication of maybe where that business can continue to grow?

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Mike Nettles, Papa John's International, Inc. - Chief Information & Digital Officer and SVP [49]

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Mark, a great question. This is Mike Nettles. So we don't really see a difference in terms of overall demographics that you're not seeing in the marketplace in general. I mean you're seeing a higher preponderance probably of your Gen Zs and your millennials and so forth that favor. Where we're seeing the biggest change, it's probably the number of our customers who have quickly gravitated and stick to use of the mobile devices. I think mobile device use in general will continue to be a very aggressive trend. We're actually looking for ways to try to leverage some partnerships in that area. We had a very successful promotion this year with T-Mobile not too recently. And there are some opportunity for us to really just recognize that mobile devices are such a unique part of the everyday experience of all consumers that people feel more comfortable using them, they feel more in control of the experience. And it gives us an opportunity to really leverage that "Better Ingredients. Better Pizza" but also a better ordering experience overall. So not so much a difference in terms of different types of people, different segments, but certainly, we're seeing a big push on the mobile, and a lot of our development investment and effort is on that platform accordingly.

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John H. Schnatter, Papa John's International, Inc. - Founder, Chairman and CEO [50]

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Mark, this is John. The digital is the future of this business. One of the negatives on the execution part of running a Papa John's restaurant is having to answer the phones. And we have weeks on corporate where we're in the mid-60s on digital percentages. I think in 2 or 3 years, the digital will be 75%, 80% of our orders.

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Steve M. Ritchie, Papa John's International, Inc. - President and COO [51]

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Mark, it's Steve. I'll just add one more piece because we've talked about this on the road with the investment community, and it kind of ties to what both Mike and John were saying there, is that some of this is just timing of adoption rate, so our corporate restaurants were early adopters in marketing initiatives to drive the digital traffic. So as John said, our overall corporate business is in the mid-60s, but we now have a multiple markets that are average on a weekly basis over 70% of digital, i.e. why we've spoken to the fact that we believe that the opportunity to get to 80% plus over the next several years here.

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Mark Eric Smith, Feltl and Company, Inc., Research Division - Senior Research Analyst [52]

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Okay. And then just following up on that. As you've gone to 60% and as you have less people answering the phones, have you been able to cut some labor? Or is the volume within the restaurant kept that labor, but maybe made it more efficient labor? And then also can you speak to the difference in check from a digital order compared to a phone in order? Are you executing on that upsell and getting higher ticket on those digital orders?

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Steve M. Ritchie, Papa John's International, Inc. - President and COO [53]

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Sure, Mark. It's Steve. I'll hit the last part of your question first. So as we have since the inception in 2001 of being the first national pizza chain to launch online ordering capability, the ticket average has been every year higher for an online customer than it is for an off-line customer. That trend has continued into 2017. But not only a higher ticket average, we also see higher levels of frequency and better overall customer experience. The introduction of our loyalty program, which was also the first in the pizza category back in 2011, think about the ticket average and frequency level there versus a traditional online customer, it's even higher within the loyalty program. So those initiatives and the functions of the future of the business are really the benefits of moving off-line customers into the digital side. The work that I know Mike will do on data segmentation and personalization of customers is really the areas where we're very much in the infancy of those opportunities, and the work that Mike's team will be doing over the next several years are really the benefits and the real improvements that we can drive to the overall margin side. The other part of your question, help me?

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Mark Eric Smith, Feltl and Company, Inc., Research Division - Senior Research Analyst [54]

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Labor.

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Steve M. Ritchie, Papa John's International, Inc. - President and COO [55]

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On the labor side? So labor now, thank you. So most of the benefits that we're getting from an efficiency standpoint, Mark, have been reinvested into customer service. As you hear us like a broken record on customer experience and the benefits of customer experience to increase overall market share, we still believe that there is an inflection point where we reach a certain level of online mix, where there will be some efficiencies in the restaurant to drive some potential improvements on the labor side of the business. But at this stage of the game, over the last several years, we've really been doing more investment with the efficiencies to drive the benefit on the customer side.

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Operator [56]

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And we have a follow-up question from the line of Alton Stump with Longbow Research.

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Alton Kemp Stump, Longbow Research LLC - Senior Research Analyst [57]

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I just wanted to ask about kind -- back to one of the questions earlier. In the first quarter, franchisees obviously pick up in discounting. I was just curious if they were happy with the response you guys saw from that in the mid to late first quarter timeframe, and kind of what their outlook is over the rest of the year, heading into 2Q and beyond from a promotional strategy standpoint?

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Steve M. Ritchie, Papa John's International, Inc. - President and COO [58]

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Sure, Alton. It's Steve. I mean I think, in general, franchisees understand the benefit of driving top line sales and taking market share. We have a metric that we look at, which is called profit after FLM. And that's profit after food, labor and mileage. So that's a component of, if you drive enough sales it can offset the potential of an increased food cost or increased labor. So our profit after FLM numbers, over the last several years, have been very strong, coming off a record profitability year for our franchisees in 2016. So I think they understand the environment, they understand that we'll have to make some decisions from time to time to implement some pricing tactics to ensure that we're still driving traffic. But overall, I think our franchise have been -- franchisees have been very happy, and understand and support the promotional decisions.

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John H. Schnatter, Papa John's International, Inc. - Founder, Chairman and CEO [59]

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Alton, it's John. I think the key to franchising is a healthy relationship, collaboration. And I give Steve the credit on this one. The franchisees -- we have the best relationship with our franchisees in the history of the company right now, and that's critical.

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Alton Kemp Stump, Longbow Research LLC - Senior Research Analyst [60]

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Got it. And then one last one. Just on the outlook on the comp front, off course you guys are sticking to the 2% to 4% guidance. Comparisons though, of course, do get quite a bit more difficult. Just to get to the midpoint of that range would imply a several hundred basis point acceleration into your stacks systemwide in North America versus wages put up in the first quarter. What kind of gives you confidence that you guys get into that full year guidance range?

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Steve M. Ritchie, Papa John's International, Inc. - President and COO [61]

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Sure, Alton. It's Steve again. I just kind of spoke to this earlier that, if you look at historically, just go back point to last year coming out of the gates a little bit softer, the 2-year stacks, a little softer in the first quarter because of the competitive activity, and the investment that we saw from our competitors, if you think about the trailing 3 quarters, the initiatives that we put in place last year, how we're going to plus up on those partnerships at the national level, at the local level. And certainly, we've got some things from a digital perspective that we also intended to drive the traffic. So I think we feel very comfortable on that 2% to 4% guidance despite the stacks, getting to your point, a little bit higher in the trailing 3 quarters.

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Operator [62]

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And I'm showing no further questions at this time. I would now like to turn the call back to Mr. Lance Tucker, CFO, for any closing remarks.

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Lance F. Tucker, Papa John's International, Inc. - CFO, Chief Administrative Officer, SVP and Treasurer [63]

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Thank you, Chelsea. We appreciate everybody's time. We will talk to you in a quarter.

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John H. Schnatter, Papa John's International, Inc. - Founder, Chairman and CEO [64]

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Thank you, Chelsea.

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Operator [65]

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Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect. Everyone, have a great day.