Papa Johns International Inc Q2 FY2020 Earnings Call

Welcome to Papa John's Second Quarter 2020 Conference Call and Webcast. My name is Sylvia, and I'll be the operator for today's call. I will now turn the call over to Steve Coke, Vice President of Investor Relations and Strategy. Steve, you may begin.

Thank you, and good morning. Joining me on the call today is President and CEO, Rob Lynch. Rob and I will share our insights on the business and provide a financial update. Following our prepared remarks, we will be open for questions. Our discussion today will include forward-looking statements that involve risks which may lead to actual results differing significantly from these statements. Please consider forward-looking statements alongside the cautionary statements in our earnings release and the risk factors outlined in our SEC filings. For a reconciliation of non-GAAP financial measures and information about temporary franchise support mentioned on this call, please refer to our earnings release in the Investor Relations section of our website. Now, I would like to hand the call over to Rob Lynch for his comments. Rob?

Thank you, Steve, and good morning, everyone. I'd like to begin by saying that I hope everyone on this call and their loved ones are healthy and safe. And by thanking those who are on the front lines of this pandemic working so hard across the globe to get us through this unprecedented situation. In Q2, we have all had to persevere through extremely challenging circumstances. Throughout the pandemic, we have worked to do our part by staying committed to delivering safe, high-quality food. We have put the safety and support of all Papa John's team members and customers at the forefront of our efforts, and we have been able to help our communities in their time of need. As sweeping processes call for social change in the United States, we have worked to lead that change within our company, and have rapidly advanced our efforts begun over 18 months ago towards creating a company and a culture that values diversity, equity, and inclusion for all. We've lived our core values, including people first, everyone belongs, and do the right thing. Those statements mean more now than ever. We recognize how trying these times are for many of our colleagues and neighbors. We at Papa John's are committed to being a force for positive change as we pursue our core purpose of bringing the world together by delivering better pizza. While these times are certainly challenging and unprecedented, Papa John's delivered outstanding performance in the second quarter. As we reported this morning, North America same-store comparable sales rose a record 28% last quarter, reflecting the hard work and dedication of our team members and franchisees in service to the millions of new and returning Papa John's customers who have relied on us to safely deliver high-quality food to their homes throughout the pandemic. We estimate that roughly half of last quarter's comp sales growth can be credited to the long-term sustainable impact of our strategy, and the remainder reflecting favorable pandemic-related changes in customer behavior, which also present long-term growth opportunities. The great responsibility and opportunity for us during this pandemic has been to serve millions of customers, new and current, who have turned to us to safely deliver delicious food. During the second quarter, we've added over 3 million new customers over digital channels alone. We also saw higher retention and repeat rates among this segment, which suggests that not only are new customers coming to Papa John's, they are returning. We saw similar dynamics internationally, where comparable sales rose 5.3%, the result of strong double-digit gains in markets like the U.K. and Korea, where delivery-based businesses continue to support their communities offset by temporary government-mandated closures in other markets. Of our approximately 2,100 international franchise stores at quarter end, approximately 225 were temporarily closed as a result of COVID-19, mostly in parts of Europe and Latin America. Excluding the impact of those temporary closures, international comp sales would have been up over 13% in the second quarter. Q2 adjusted earnings per share tripled from $0.16 to $0.48, driven by top line growth and accelerated by operating leverage. Strong earnings year-to-date have generated $67 million in free cash flow, compared to just $9 million over that same period last year, and we have reduced our net debt by almost $80 million from a year ago. As we reported this morning, July sales indicate that our strong momentum continues into the third quarter. Domestic comparable sales were up over 30% in July in North America, an acceleration in our growth compared to June. International comp sales were up 14%, a record for our international business. Excluding temporary closures, international comp sales would have been up 17%. As of today, we have approximately 160 stores temporarily closed in our international markets. Clearly, strong sales drivers from Q2 have remained intact. We are leveraging our loyalty platform and one-to-one marketing capabilities to ensure that we keep these customers long after the pandemic subsides. As I said, these strong results are an outcome of two things. The first, the benefit that we are deriving from the changing dynamics in the restaurant industry driven by the pandemic; and second, the positive impact of the progress that we have made against our strategic priorities established in Q4 of 2019. As we discussed last quarter, those five strategic priorities are: one, building a culture that is focused on diversity, inclusion, and winning; two, improving unit economics; three, reestablishing the superiority of our products through commercial innovation; four, building a technology infrastructure that supports our business platforms; and lastly, expanding our footprint domestically and internationally. I'd like to begin by talking about the progress that we have made in building a diverse and inclusive culture that is focused on winning. Our ability to connect Papa John's values with how the country, our customers, and our employees are feeling right now has helped improve sentiment for the brand. Communications has played a big role here. Our campaigns for no-contact delivery in March and April, recognizing our frontline workers and customers in May, and for the Shaq-a-Roni in July have all leaned into Papa John's core values. We have seen significant positive impact on consumer sentiment towards our brand as a result. At this time of great need for many of our neighbors, we have increased our investments through the Papa John's Foundation into nonprofit organizations that serve our communities. We've provided millions of free slices of pizza to healthcare workers, first responders, and organizations on the front lines of this crisis. We've also launched our first fundraiser for the Papa John's Foundation for building community, which I will talk about more in a minute. To address our surging need for team members, we launched a national recruiting campaign and have hired over 20,000 new restaurant employees, many of whom had lost jobs because of the pandemic. Last week, we extended our earlier campaign and have set a goal of hiring another 10,000 restaurant team members over the next few months to help us meet sustained customer demand. We also announced that we have made our best-in-class college tuition program, Dough & Degrees, even stronger with two new university partners. All eligible team members and their immediate family members have access to an affordable online college education, which is even more important with the economic stresses many are feeling right now and the uncertainty around returning to in-person school in the fall. I now would like to turn to the progress that we have made in our restaurants and the impact that we are having on unit economics across our system. As we have previously discussed, our top priority has always been the health and safety of our team members and customers, especially now given the uncertainties associated with COVID-19. From the beginning of the pandemic, we have taken decisive actions to protect our team members and customers. We enhanced our already rigorous hygiene and food safety protocols, we provided special bonuses and incentives for many of our frontline employees, and we increased our health and wellness benefits for all team members and their families. We also quickly reengineered our ordering and delivery processes and technology to seamlessly integrate no-contact delivery into our channels and customer experience. No-contact delivery has been a huge success with customers and team members. We have secured our supply chain, reviewing our sourcing relationships and protecting the health and safety of our team members at our quality control centers to ensure that there are no disruptions to our business or ability to serve our customers. As a result of these actions and the perseverance of our team members and franchisees, Papa John's record sales dynamics are transforming the profitability of our corporate stores and our franchisee stores. And in turn, have further strengthened our long-term outlook for store growth. Continuing first quarter's positive trend, and despite record high cheese prices, second quarter North America unit profits and margins were the highest that we have seen in several years. Strong unit economics will be the foundation for strong development moving forward. Next, I'd like to address how successful innovation has reestablished the superiority of Papa John's products over the past three quarters, contributing to accelerating positive sales comps. Across the company and our system, we are very excited about the marketing product and e-commerce progress that we have made and the commensurate impact that our innovation mindset is having on our business. Our menu innovations, including Garlic Parmesan Crust, toasted handheld Papadias, and Jalapeno Popper Rolls, continue to be popular and successful with customers and our bottom line. These new products all build on Papa John's signature crust and better ingredients, better pizza brand positioning to drive higher ticket and traffic across dayparts without cannibalizing core premium products or adding costs or significant operational complexity to our stores. This innovation strategy has helped to minimize our need to offer deep discounts to give customers incentive to order from us. And as a result, it's driving both sales and profitability. The product innovation pipeline continues into the third quarter. Last month, we launched our new Shaq-a-Roni pizza in collaboration with Shaquille O'Neal, Papa John's Board member and restaurant owner. The Shaq-a-Roni is an extra-large pizza made with our signature dough topped with extra cheese and extra pepperoni to the edges and cut into Papa John's largest slices ever. As part of the launch, we are donating $1 from every Shaq-a-Roni sold through August 23 to the Papa John's Foundation for building community, which benefits COVID-19 relief efforts and organizations like the United Negro College Fund and Boys & Girls Clubs of America that support communities working together for equitable opportunities for all. The Shaq-a-Roni has had a huge start, already selling over 2 million pieces and raising more than $2 million to support our communities. Clearly, this reflects the appeal and quality of the product as well as a positive message and advertising campaign that really resonates with consumers in the current environment. We look forward to investing the funds raised from our foundation back into our communities to continue to support COVID relief in the fight against racial injustice. As you know, technology is a big part of everything that we do. Part of our competitive advantage in the restaurant marketplace is that we are an e-commerce business. Approximately 70% of our orders are placed on digital channels, and mobile ordering is our fastest growing platform. This capability positions us well for the foreseeable future as customer ordering and consumption behavior continues to be affected by the pandemic, possibly with long-term impact. In addition, our progress on the utilization of our loyalty and one-to-one marketing platforms is accelerating our growth. But how we leverage technology does not stop at our front door. We have built strong relationships with external technology companies that allow us to meet the needs of more customers than we could alone. Papa John's robust partnerships with three of the four top delivery aggregators already in place before the pandemic have further enabled us to meet surging customer demand, especially during peak times when our delivery teams are working at full capacity. In fact, the percentage of our transactions delivered by aggregators was up more than 100% in Q2 versus Q1. These transactions are highly incremental and profitable for our business. As we have said repeatedly, Papa John's strategy is to win by providing our customers with better pizza wherever they are and however they choose to order. Lastly, I'd like to discuss our new store development, another focus area for our long-term growth. With permitting suspended by most local governments during the pandemic, new store openings paused as expected during the quarter. However, strong sales and profitability reduced closures of traditional North America franchises to the lowest rate we have seen in 10 years. After managing through significant challenges in 2018 and 2019, Papa John's domestic franchisees are in a stronger position today than they have ever been. Strong sales and improving margins provide a strong foundation for our new development strategy in the U.S. and internationally. Even before this quarter, Papa John's offered franchise investors one of the fastest paybacks in our industry. This compelling investment opportunity is now even more compelling given three significant changing dynamics in our industry. The first, our e-commerce and delivery model is set up to succeed in an environment where our communities are apprehensive about sit-down dining. The second, the expected availability of many attractive retail real estate opportunities in the months ahead also provides room for expansion that may not have been available just six months ago. And lastly, our company's transformation is creating a brand that we can all be proud of, both prospective franchisees and top-performing team members. To take advantage of this opportunity, we have ramped up our development efforts with new leadership and resources to drive our franchisee success. We are focused on delivering significant unit growth moving forward. I'd now like to turn the call over to Steve Coke to provide more color on our Q2 results before I deliver our closing comments. Steve?

Thank you, Rob. I'm going to start today by walking you through our year-over-year earnings, followed by some highlights from our second quarter operating results. In the second quarter, we reported earnings per diluted share on a GAAP basis of $0.48 compared to $0.15 a year ago. Excluding a $0.01 impact from special charges in the prior year, adjusted earnings per diluted share rose from $0.16 a year ago to $0.48 this year. The $0.32 year-over-year increase reflects a $0.37 positive benefit from improved operating results, primarily driven by our record North America comparable sales. This was slightly offset by a $0.05 negative impact from the allocation of undistributed earnings to participating securities, primarily the Series B preferred shareholders. Undistributed earnings are defined as net income less dividends paid. The allocation of these earnings is determined by the percentage of total outstanding shares that the participating securities would represent on an as converted basis. In prior quarters, there were no undistributed earnings to allocate to these participating securities. However, based on the company's performance in the second quarter, undistributed earnings were available for the quarter-to-date and year-to-date earnings per share calculations. We also provided $5.1 million or approximately $0.12 per share in scheduled royalty relief as temporary franchise support under the formal We Win Together program. This compares to $5 million, also approximately $0.12 per share provided in the second quarter of 2019, which was comprised of both incremental marketing fund investments and royalty relief. This temporary franchise support provided under We Win Together will conclude in the third quarter with $10 million in incremental marketing investments and to a much lesser extent, royalty relief. After the formal release concludes in the third quarter, we do not expect to provide additional temporary franchise support under the We Win Together program in the fourth quarter or next year. This anticipated spending compares to the $37 million we spent in the last two quarters of 2019. Moving now to more detailed operating results. In the second quarter of 2020, pretax income on a GAAP basis was $26.9 million compared to $10 million for the corresponding quarter in 2019. As Rob described, consolidated second quarter revenues rose 15.3% or $61 million. Excluding the impact of refranchising 46 domestic restaurants and a quality control center in Mexico in 2019, consolidated revenues increased approximately 18.3% or $71.1 million. The increase was largely due to positive comparable sales in North America, which drove higher sales for domestic company-owned restaurants, North America franchise royalties, and North America commissary revenues. Now for our business unit results for the second quarter. Domestic company-owned restaurants pretax income increased $9.2 million primarily from positive comparable sales of 22.6% and operating leverage, partially offset by higher labor and bonuses. North America commissaries pretax income increased $800,000 and primarily driven by higher profits from higher volumes. North America franchising pretax income was $4.3 million higher, driven by a 29.7% increase in comparable sales partially offset by higher royalty relief under the temporary franchise support program. International pretax income decreased $800,000, primarily due to targeted royalty support provided to certain franchisees and the unfavorable impact of foreign exchange rates. These decreases were partially offset by lower travel costs due to COVID-19 restrictions and higher royalty revenues and U.K. commissary income from increased units and higher comparable sales. All others pretax income increased $3.2 million, primarily due to higher online revenues related to strong North America comparable sales. Unallocated corporate expenses decreased $1.1 million, primarily due to a $2.5 million incremental marketing fund investment in the prior-year quarter included in temporary franchise support, savings from the cancellation of our Annual Operators Conference and reduced travel as a result of COVID-19 as well as lower professional and consulting fees and lower interest costs. These decreases were partially offset by higher projected management incentive costs. Income tax expense was $5 million for the second quarter of 2020, for an effective tax rate of 18.4%. Now turning to cash. Our free cash flow, which is a non-GAAP measure that we define as cash flow from operations less capital expenditures and dividends paid to preferred shareholders, was approximately $67 million in the first half of 2020 as compared to $9 million a year ago. The $58 million increase was primarily due to higher net income as well as favorable changes in working capital items, including the timing of payments associated with our marketing fund. The company has a secured term loan facility with an outstanding balance of $350 million. The outstanding debt is 100% fixed with swaps at favorable interest rates. With a low fixed rate and current leverage ratio of 2.9x EBITDA, we continue to believe maintaining our cash balance during this uncertain environment is appropriate. Additionally, borrowings of up to an additional $400 million are available under a secured revolving credit facility should we need it. Both facilities mature in August 2022. We paid a cash dividend of $10.7 million to our common and preferred shareholders during the second quarter of 2020. Subsequent to the second quarter, on July 31, 2020, our Board of Directors declared third quarter cash dividends of approximately $10.8 million to be paid to common and preferred shareholders. The third quarter common stock cash dividends will be $0.225 per common share. Lastly, during the second quarter, we opened 9 restaurants in North America and closed 10 restaurants for a net reduction of 1 restaurant. As Rob noted, while new restaurant openings have been slow during the pandemic, last quarter's North America closures included only three traditional restaurants, which was the lowest rate we have seen in a decade. Internationally, we opened 25 restaurants and closed 55 restaurants, for a net reduction of 30 restaurants. The majority of international closures were associated with a strategic franchise realignment in a single market. We expect to reopen most of these restaurants under a new franchisee. These changes in our unit count exclude any temporary closures as a result of the COVID-19 pandemic. I'll now turn the call back over to Rob for some final comments.

Thanks, Steve. Finally, to summarize and wrap up. In a very difficult environment for many businesses, especially in the restaurant industry, Papa John's has shown tremendous strength in the second quarter. And as we disclosed, this has continued into July. Our transformation and the values and purpose upon which it is based, have enabled us to respond to an unprecedented situation, protecting the safety of our team members and customers while keeping our doors open and continuing to serve our communities. Our new products and marketing continue to perform very strongly. Our innovation pipeline continues to produce great ideas that bring in new customers, engage our current customers, and deliver results. Our franchisees, owners of small local businesses are realizing unprecedented profitability that will allow them to invest in growth as well. And through it all, we are building an organization that we can all be proud of. Like everybody, we wish for the end of the pandemic, a speedy economic recovery, and a return to normal for all of us. But given the ongoing challenges and uncertainty related to COVID-19, we expect that social distancing, both voluntary and enforced, will continue to drive consumers toward delivery and carry-out-based businesses like ours for the foreseeable future. We will continue to put the health and safety of our team members and customers at the forefront as we continue to serve our communities. We will also continue to optimize our workstreams in response to the ever-evolving changes in the business conditions and in customer needs, but we will always stay true to our values and purpose, which have been our guidepost as we have navigated these uncertain times. We remain focused on our long-term goals, confident that our actions today are creating a foundation for a strong brand and profitable growth long after the pandemic subsides. I'd like to thank our shareholders and everyone on this call for their interest in our company and their continued support. With that, I'll turn the call over to the operator for Q&A. Thank you.

Our first question comes from Peter Saleh from BTIG.

Congratulations on the quarter and the results. Rob, you mentioned during the call that you are increasing development efforts. Could you provide more details on that? I noticed the closure rate was relatively low this quarter. Is there any reason to believe that closure rate won't improve moving forward?

Peter, yes, development is probably my number one priority right now. I feel like we've built a very strong foundation on our commercial business in North America. We've got great innovation, great marketing support. The next phase of the turnaround of this company is getting development ramped up and going again. To that end, earlier this year, we hired a new Chief Development Officer. We previously had not had a Chief Development Officer. We brought her in to really get a best-in-class infrastructure built to facilitate development moving forward, and we've put some very aggressive goals in place for ourselves heading into next year and beyond. So right now, we're building the infrastructure to be able to support that. So we're building best-in-class capabilities that, frankly, we didn't have before in terms of how we think about the territories, both domestically as well as internationally. And there's a ton of white space for us. We've got half as many restaurants as our competitors in North America and way less than that internationally. We operate in 47 countries internationally, which is about half of our top two competitors. So we feel like there is a huge development opportunity here. We have a significant amount of excitement, both with our current franchisees who have cash flow at this point and capital that they want to reinvest in the growth of this business. We're also being contacted by many large, sophisticated owners of other concepts both domestically and internationally, who want to be a part of the pizza business as it has proven to be very successful during these challenging times. And a lot of people believe that our model, which is unique in the marketplace because it is an e-commerce and already built-out e-commerce and delivery model is something that they want to build into their platforms. So development is a huge focus for us. We see a huge amount of opportunity. In terms of closures, I don't see why anyone would close a Papa John's for the foreseeable future. The margin structure is great. The revenues are great. We're hiring team members. We're finally getting to a point where our restaurant staff takes the burden off of the operators. So I foresee our closure rate being very low for the foreseeable future.

And then can you just talk about the advertising budget? I know coming into this year, nobody really expected these types of comps. And so, therefore, I'm sure your ad budget has kind of ballooned. How do you plan to spend, I guess, the incremental ad dollars that you have in your pocket now versus the initial plan? And is there any opportunity to roll some of that into '21 if you don't seem to need it in this year?

That's a great question. When I came into this business, obviously, my background in marketing, one of the concerns that I had was we had this We Win Together program, which is a great program, helping our franchisees through the challenging situation that they were facing. And about half of that support was in the form of marketing spread out over 2019 and 2020. And so as we look at 2021, my concern was that our marketing budget would decline relatively precipitously, given that if we were ending that level of support, these sales have mitigated that issue. Our comp sales this year, as you know, our marketing budgets are a function of our sales growth, our net sales. And so as our sales have gone up, it's still the marketing bucket for us. And yes, we have the flexibility and capability to move funding of marketing funds from one year to the next. So we are currently exploring what the best strategy is to do that. Had a call about it yesterday. So absolutely, we will make sure that we continue that momentum to close 2020 strong. But we're absolutely looking at the opportunity to make sure that we get off to a fast start in 2021, leveraging our marketing dollars most productively.

Your next question comes from Alex Slagle from Jefferies.

I see the business performing exceptionally well and making a meaningful impact. Considering the digital platform, data analytics, and consumer-facing technology, what do you identify as the next opportunity for the brand to elevate itself? Additionally, are there any immediate opportunities you would highlight at this stage?

Great question. Over the last three months, we have gained more than 3 million new customers through our digital channels, and one of our top priorities is ensuring their retention. We aim to provide excellent service and timely delivery of our best products while making our digital platforms as user-friendly and efficient as possible. This is essential for encouraging repeat business. As we mentioned last quarter, we revamped our loyalty program in 2019, and we are starting to see positive results in 2020, including higher average order values as we better target incentives to the right customers. Our one-to-one marketing capabilities, utilizing our data and loyalty programs, are really starting to excel. We are making significant investments in loyalty and personalized marketing to ensure these new customers contributing to our transaction growth stay with us. From a commercial perspective, that’s where our major investments lie. Additionally, we are optimizing our collaboration with aggregators, who now represent over 5% of our business. Their growth during the pandemic has benefited us, as we are among the largest suppliers on their platforms due to our delivery operations. We are working to ensure we continue to provide excellent service through their platforms while establishing a viable long-term model that supports both our businesses in a profitable manner for our customers. Our technology focus is heavily centered around our loyalty program and our partnerships with aggregators.

That's helpful. Could you help us analyze core general and administrative growth, excluding the special charges from the past couple of years? Looking back to around 2017, it was roughly $150 million to $160 million. Today, however, you operate fewer restaurants in the U.S. and internationally and have sold some commissaries. Simultaneously, you're investing to rebuild the business and prepare for growth acceleration. How should we balance these considerations and understand G&A going forward? Do you have any insights on the target G&A as a percentage of system sales?

Yes. I mean, this year, going into 2020, it was the first year where we had actually built a plan that decreased G&A in the last three years. So we are very focused on G&A. We are hyper-focused on being as productive as possible. This is going to be a little bit of a unique year in terms of absolute G&A because as our sales and profits continue to rise, we will see a change from last year where we had very minimal management incentives to this year where we will have a relatively significant management incentive program payout. So our G&A will be a little bit skewed this year. By that, our focus and our targets are to continue to reduce G&A year in and year out. And we were making a lot of progress towards that. These unique dynamics are going to change that a little bit this year.

Our following question comes from Chris O'Cull from Stifel.

Rob, can you elaborate on how the company has been able to disaggregate the comp performance between the pandemic and company-specific initiatives?

Yes, as you know, Chris, we were experiencing about 7.5% growth in the first quarter before the pandemic hit, but we saw a dip in sales initially. However, as people began to stock up and stay at home, we recovered and experienced a significant increase in sales and comparable store sales. We have been monitoring this progress closely, focusing on consistent drivers of our business such as our innovation pipeline and the product mix, as well as evaluating the impact of these initiatives. We're also paying attention to the competitive landscape, where major national pizza delivery companies have reported growth in their delivery segment at around 15%. Before the pandemic, our competitors saw flat to 1% growth. We are analyzing the growth they have experienced during the pandemic and comparing it to our own growth. We believe our unique strategies have created substantial opportunities for growth, including our partnerships with major aggregators, which we view as beneficial. We expect to continue reaping rewards from this strategy. Our innovation efforts and our ability to analyze purchase data across digital channels are also yielding positive results. For instance, since the launch of Papadias, our average order size has dramatically increased, which is attributable to our strategic initiatives rather than the pandemic. Additionally, we have introduced the Shaq-a-Roni, an extra-large pizza that donates $1 to charity, which is performing better than we anticipated and driving repeat business. Overall, we differentiate between the impact of the pandemic and the effects of our strategic priorities by tracking and measuring our specific actions.

That's helpful. And then do you expect the marketing fund to be up year-over-year in '21 without the company making a contribution to the national ad fund?

Yes. We do.

Great. And then once you have the infrastructure in place, what do you think are going to be the greatest challenges the company needs to overcome in order to restart or see franchise development accelerate?

Part of it is in our hands, which is exciting because we have the ability to shape our future. We have lacked some critical capabilities for top-tier development related to new technologies for creating trade areas and mapping. Our infrastructure has not effectively supported franchisees. Many of our franchisees over the past several years have been individuals with one or two units, and we haven't had the infrastructure necessary to expand our offering to larger, more sophisticated franchisees who already manage other concepts. This presents a significant opportunity for us, and we are actively focused on it, with considerable interest emerging. It's something we can control since the economics are very appealing. For instance, the cost to open a Papa John's Pizza Restaurant is around $300,000, and with the average unit volumes we are currently delivering, which we aim to maintain, the return on investment is among the best in the industry. We have not effectively communicated this, and we haven't reached the right audience. Therefore, we are preparing to emerge from this situation domestically with partners eager to invest in our brand, ensuring we have the necessary resources to support them. Internationally, there are vast markets that remain untapped. For example, we do not have any restaurants in Australia, a major QSR pizza market, nor in Africa. We are present in only half the countries where our competitors operate, and even in places like China where we have 200 restaurants, our competitors boast thousands. There is a significant amount of opportunity available, and it is about us putting the resources in place to seize it. We are currently making those investments to be ready for substantial growth once we navigate through this period.

Our next question comes from Brian Bittner from Oppenheimer.

Rob and Steve. This outlook for improving unit growth is definitely a new important theme at Papa John's, and you just touched on it a bit with Chris' question. But when do you, from a timeline perspective, really expect to see new unit openings start to positively impact the growth of the business? I mean, is it going to be right on the other side of this virus? Is it going to be by the end of this year? Just some color around the insights you have on the timing of this new unit growth theme?

Brian, good to hear from you. Barring unforeseen circumstances, and that used to be a pop-out, but these days is completely relevant. Barring unforeseen circumstances, we are targeting a significant growth in units in 2021. So we are building the infrastructure right now. We are working to make up for lost ground that we're losing right now given the challenging dynamics around getting restaurants built. But we think there's going to be a big opportunity. We haven't necessarily seen the shakeout from the pandemic yet on the real estate market. I think as this thing continues to linger, there will be a shakeout. There will be real estate that becomes available that wasn't available before. And we want to be able to take advantage of that and leverage that opportunity in the near term. So like I said, we are building right now. We are preparing right now. We are ramping up right now. How long that is going to take before it really gets up and running, it's probably more dependent upon how the pandemic continues to impact development more so than our individual action plan.

And my follow-up just July same-store sales obviously accelerating from June. You know it's happening at a time when we're seeing sales improved for more traditional restaurants, I guess, meaning the pandemic becoming less of a drag in July for traditional restaurants? So you've been able to actually improve the momentum at a time where, I guess, logic would say the positive impacts from the pandemic are becoming less for your business. So does that mean some of the core underlying drivers of your business are actually really accelerating? And you're kind of seeing the pandemic's impact lessen as we move into July? Or how would you frame that up?

Yes, you're correct. As I mentioned, our current goal is to retain the customers we have acquired over the last three months and encourage their continued patronage at Papa John's. So far, we've been successful in this effort. Our repeat rates are on the rise, and our customer service scores are exceptionally high. I must commend our operations teams, both at the company level and among our franchisees. We've experienced a substantial increase in transactions, and our restaurants have managed to handle this growth smoothly while also enhancing customer service metrics. We are well-equipped to manage these increases. However, it's crucial that we maintain these customers; otherwise, we risk a one-time gain. A lot of current models reflect the temporary boost from the lockdown, but what we need to focus on is retaining the customers who are now choosing us. They did not come to us solely because of COVID-19; they are likely to continue their patronage. I believe there will be lasting behavior changes that brought them to us, and we are providing better service than they might have experienced with other pizza chains. Consequently, they are realizing that Papa John's is a brand they want to support not just during the pandemic, but beyond. I see strong potential for continued loyalty, which we can enhance further through our loyalty program and personalized marketing efforts. I mentioned in Q4 and at the end of Q1 that we had significant untapped potential. We had around 12.5 million members in our loyalty program back then, and we're nearing 16 million now. We've recognized that we haven't fully utilized this valuable customer data yet, but we're now beginning to do so. There's a tremendous opportunity to keep these customers and encourage more frequent visits by making the most of our loyalty program. I anticipate that this positive momentum will continue for quite a while.

Our following question comes from Lauren Silberman from Crédit Suisse.

Congratulations on a great quarter. You were talking about appetite for new unit growth from both new and existing franchisees. So with that, to what extent could refranchising play a role in accelerating new unit growth, particularly in North America? And to what extent do you expect new unit growth to come from new versus existing franchisees?

Well, we are in a great situation with that. We own almost 20% of the restaurants domestically, which does give us an asset base to seed new franchisees with new unit growth. Lauren, as you know, in this industry, big players don't want to come in and start from zero. They want to come in and have a base of operations that they can spread their overhead costs across and then start building. So we are in active talks with large franchisees right now about that opportunity. So it's definitely an advantage for us having as many restaurants as we have. That being said, I would also tell you that the return on invested capital on these things is so great right now, that we're also thinking there could be unit growth from us. We are in a better capital situation with very low levels of debt and lots of cash flow right now. We're exploring how we're going to leverage that cash flow. We want to make sure that it's invested in a way that maximizes shareholder return. And right now, building some restaurants in some of these markets may not be necessarily the worst thing to do either. So we are exploring all opportunities, both refranchising to see ongoing significant growth in unit development, but also potentially investing some of our own capital into some of these markets, which will build out these markets and potentially make them even more appealing for refranchising. And so when you talk about the balance between current franchisees and new franchisees, one of the outages with this system in the last five years has been very low levels of development with current franchisees. One of the biggest motivators for current franchisees to develop is new franchisees. So I think that we will see a pretty good balance moving forward from both new franchisees as well as our current franchisees.

Great. And then how can we think about the composition of unit growth over even next year and over the next three years between North America and international?

International is probably going to outpace domestic for the foreseeable future just because there is so much white space left. We have so many geographies that are still underdeveloped. And we have a model internationally where we have master franchisees that are well capitalized on other concepts and are set out to develop. The domestic franchisee base and the domestic development, we need to do some work there. And part of that work is kind of the mapping that I talked to you about, making sure that we have the appropriate trade areas set up, and we have set our current franchisees up with opportunities to go and build. So I would see that ongoing, our international development is still a bigger contributor to our total development, but the ratios will change and domestic will become a bigger part, just that international will continue to be the driver.

Great. And then just as it relates to your delivery versus carryout business, can you give any color on the relative performance in the quarter and into July? And then how do we think about that relative profitability of each channel, maybe delivery through your own system, through aggregators, and then carryout? Are they all reasonably at parity?

It's interesting that we haven't observed as much growth in the delivery business as we initially anticipated. Our ratios remain relatively stable, which indicates something about our customers. Despite the shift to no-contact delivery, people still appreciate going out in their own cars to get their food and bring it home. Therefore, our ratios haven't changed significantly. While our carryout business tends to be slightly more profitable, I don't believe the difference is as substantial as is often suggested, since we need delivery drivers regardless of whether customers are picking up their orders. The variable costs for delivery are covered by the delivery fees, so we view carryout and delivery as comparable in terms of profitability. Additionally, we see the aggregator model similarly regarding profitability due to the favorable terms we've established and the cost structure relative to our delivery channel. At present, all these models are functioning productively and efficiently. As you know, in the quick-service restaurant sector, volume addresses many challenges. We need delivery drivers available to meet potential demand, and currently, that demand is present, allowing us to optimize our labor investment. Thus, we are pleased with the margin expansion we've experienced.

Our following question comes from Alton Stump from Longbow Research.

Congrats Rob and Steve, I mean great results. So I just wanted to ask two questions. First off, kind of going back to Brian's question about the July comp accelerating, which certainly is a surprise, given the market dynamics, how much of that do you think was due to Shaq-a-Roni, that was obviously the big new product in July? And kind of to that point, how much of that incremental uptick in July was due to average ticket versus traffic?

That’s a great question. We haven’t discussed it much, but in June, we had no national media as part of our strategy for the year following the pandemic. In April, it wasn't efficient for us to purchase spot media to support business growth. Consequently, June sales and the change in the sales rate were partially influenced by turning off the national media that had been successful for us in the first quarter. In July, with the launch of Shaq-a-Roni, we fully utilized a great product that garnered significant PR excitement through its association with Shaq, supported by extensive national media tailored to the current situation, which included a charitable component. Shaq-a-Roni is more than just a new product; it represents our innovation mindset in product, marketing, and technology, showcasing what we can achieve through smart commercial strategies. So yes, the increase was driven by Shaq-a-Roni, but it wasn't solely because it's a Shaq pizza. It was also about reactivating national media, leveraging our PR efforts, and being timely with our charitable giving. I hope that answers your question.

Yes. No, it does. Thanks for color, it's very interesting. Secondly, kind of back to the question about, as you're starting to build either more company-owned and/or franchise, kind of following all that, when times are good you want to build a company or stores and when bad, you want to sell them back to franchisees. But given that, is there any preference that you had to choose between adding more stores on the company-owned front versus selling your franchisees? Or are all options being explored equally currently?

Yes. I mean, we've talked about since I got here that I really like the optionality of owning restaurants and leveraging our balance sheet to create shareholder value. I will tell you that our bias is absolutely to refranchise restaurants and see great new franchisees with development opportunity. So every opportunity where we can do that, we are exploring it very diligently; it's something that we see as part of our future. So refranchising to see development is probably a priority over any build-out of company restaurants.

Our following question comes from Brett Levy from MKM Partners.

A couple of questions. First, if you could build off of Brian's question earlier about what you're learning from your consumers, just given all of this robust data you've been able to attract and acquire from all your digital and loyalty programs, what have you really learned about your customer? Second, when you think about the back half of the year and into 2021, how should we think about the level of campaigns, frequency of campaigns, integration of newness on the menu and core? And then just for you, Rob, you're coming up on a year. Obviously, you've had really four different tranches of experience. What do you think has changed most in your plan and your approach over that time frame, excluding the shift to a contactless society? And I'll stop there.

Those are all really interesting questions. I appreciate you acknowledging my one-year anniversary. I was hoping for a cake from the team today, but that didn't happen. It has been a fascinating year. The challenges facing our country, society, and the restaurant industry were unexpected. I would say, and this may sound odd, but it’s true: nothing has really changed for us due to the pandemic and other challenges we face except that we're working remotely. Everything we were developing in Q4 and Q1 aligns with what we're doing now; it’s just been accelerated. Our efforts to improve our company and culture and how we treat each other have definitely sped up over the last two months. Our innovation pipeline has been expedited, and our operational improvements have been ramped up to manage increased demand. Our technology infrastructure investments have also been fast-tracked, and our commitment to development coming out of this has similarly increased. The most significant change is the rate of change itself. We came in and replaced some key leadership team members and implemented our strategic priorities. None of that has changed. We have the right team focused on the right objectives, with more resources allocated to accelerate all initiatives. Regarding next year and the frequency of our campaigns, we initially planned about six innovations this year, with each limited-time offer lasting around two months. This approach has evolved to meet the business's needs. During the pandemic, as we experienced a surge in transactions, we focused on our core business rather than introducing many new innovations. The Shaq-a-Roni has been the only new product launched since Papadias, but that doesn't mean we stopped innovating. We've been testing and developing ideas consistently, and we have numerous great concepts ready to launch. We'll introduce these when we see the best opportunities and can manage them without adding complexity or compromising our operational effectiveness. Lastly, regarding our understanding of customers, we've observed a marked improvement in our ability to retain new customers, with significant increases in repeat rates compared to pre-pandemic levels. This improvement is partly due to enhancements in our loyalty program and digital platforms, resulting in a positive customer experience. Surprisingly, our customer service has improved because we can hire more staff. We're deploying more drivers and maintaining service times, and our no-contact delivery has elevated our service levels. The retention of new customers is an area where we’ve discovered a big opportunity. Among our existing customers, the biggest change has been in the ratio of items per order—while the number of items has remained fairly consistent, the size of orders has increased significantly. This is due to customers adding Papadias and Jalapeno Popper Rolls to their existing pizza orders, driving substantial ticket growth. We’ve increased ticket sizes without raising prices this year, indicating healthy growth driven by customers wanting to add items to their orders. We plan to continue leveraging this trend in our innovation pipeline. I hope that answers all three of your questions.

We have time for one more question this morning. And your last question comes from Greg Badishkanian from Wolfe Research.

It's actually Fred Wightman on for Greg. Just wondering if you could break down the July performance a little bit across geographies. Are you seeing any divergence in terms of states that are farther along in terms of reopening or subsequently if ones that are seeing an uptick in infections?

No, we're not. I mean, we are seeing growth across all of our geographies. And even in markets like New York City, where the rates have come down dramatically, and as the change in dynamic from where they were, our sales continue to exceed far exceed our expectations. There has not been a real regionality to our growth, which initially, we thought there would be, and I think in our last call, we talked about how New York and some of these other more urban markets impacted in a greater way were outpacing in terms of sales growth. They still are, but that hasn't changed. So it gives us a lot of confidence that what we're doing is not absolutely beholden to the dynamics that are impacting each of these markets differently.

Great. And then just one final one on the development front. A lot of positive commentary as far as unit growth into next year. But when do you think that we'll start to see those development pipeline statistics increase? Is that something that will be next quarter or a little bit longer down the road?

Yes, if I could leave you with one thought, it would be that we are just getting started. I understand that over the past year, we’ve experienced strong stock performance and solid business outcomes. However, it would be a mistake to think that, due to the pandemic, this is the peak for Papa John's. We still have significant growth potential ahead. This potential comes from both comparable sales and development opportunities. In fact, I believe the development opportunity is even greater than that from comparable sales, as it hasn’t been fully realized in recent years. The closures that occurred recently now open up those sites for new restaurants. We are just beginning to develop our strategy, but this process won’t happen overnight. We need to establish a development capability that can match the growth we anticipate. I wouldn’t want to mislead you into thinking that we will see a sudden increase in development in the third quarter. What I can say is that we are currently planning for 2021 and are aiming for a significant growth rate in development for that year.

At this time, I will turn the call over to Rob Lynch for closing remarks.

Thank you all for joining us. We hope you share our excitement for the future of Papa John's. The investments and strategic decisions we made at the end of 2019 and into the first quarter of 2020 have set us up to thrive in both the current environment and in the long term. We're just beginning this journey, and a year in, we see great potential ahead. The brand is strong, and all our metrics are improving. We're attracting new customers at an accelerated pace, and they are returning more frequently than our core customers used to. These positive metrics suggest a very bright future. We look forward to updating you on our continued momentum, and we wish you all well and safe until we speak again soon. Thank you.

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.