Papa John's International Inc

NASDAQ:PZZA

Earnings Call Transcript 2021-Q1

[Operator]

Good day. And thank you for standing by welcome to the Papa John's First Quarter 2021 Conference Call and Webcast. [Operator Instructions] Please be advised that today's conference is being recorded. [Operator Instructions].

I'm now turning the call over to Mr. Steve Coke, Senior Vice President of Financial Operations, Accounting and Reporting.

[Steve Coke]

Thank you. Good morning everyone. Joining me on the call today are our President and CEO, Rob Lynch, and our CFO, Ann Gugino. Robin and Ann will comment on our business and provide a financial update. After the prepared remarks, both will be available for Q&A. Our discussion today will contain forward-looking statements involving risk that could cause actual results to differ materially from these statements.

Forward-Looking statements should be considered in conjunction with the cautionary statements in our earnings release, and the risk factors included in our SEC filings. Please refer to our earnings release and the Investor Relations section of our website for a reconciliation of non-GAAP financial measures discussed on this call.

Finally, we ask any members of the media to be in a listen-only mode. Now I'd like to turn the call over to Rob Lynch for his comments. Rob?

[Rob Lynch, President and Chief Executive Officer]

Thank you, Steve. And welcome everyone to our 2021 first quarter earnings call. One year ago none of us could have foreseen the challenges ahead and the hard work that would be required to persevere through a global pandemic. Today we are more grateful than ever for the tremendous effort and sacrifices that our team members and frontline workers have made to take care of their communities in their time of need. It is through their hard work and determination that Papa John's delivered one of the best years in the company's history in 2020.

I'm pleased to report today that we have continued that momentum into 2021 with a very strong start to Q1, delivering our sixth straight quarter of comp sales out performance versus the pizza industry, and a seventh straight quarter of positive global sales growth. In addition, our unit growth has accelerated and our adjusted earnings per share grew 500%. The company purpose core values and strategic plan that we put in place late in 2019 have provided the continued direction and the foundation that underscores Papa John's industry outperformance and positive long-term outlook.

I'd like to cover three items this morning. First I will discuss our first quarter results and their drivers. Second, I will comment on how the dynamic market environment and evolving consumer behavior position Papa John's favorably going forward. And third I'll provide some comments on Papa John's strong near-term and long-term outlook as we continue innovating against every facet of our business and executing our strategy with excellence. I'll then turn the call over to Ann to discuss our financial results in more detail and provide some additional color on our near-term outlook.

Papa John's system-wide sales continued climbing in Q1, driving a nearly 25% increase in revenue to $512 million. In North America, Q1 comp sales rose 26.2%, over the same period one-year ago we recorded comp sales growth of 5.3%. So on a two-year basis North America comp sales were up over 31% last quarter. This strong year-on-year performance is indicative of how our business continues to build momentum and gives us confidence in our ability to successfully comp our comps moving forward.

Internationally comp sales were up 23.2% building on a 2.3% increase a year ago for a 25.5% two-year comp. Our international business continues to exceed our expectations across most geographies, regardless of how they are currently dealing with the pandemic. Strong operating leverage on higher sales and the conclusion of temporary franchise support last year helped us grow adjusted EPS from $0.15 to $0.90 excluding special items.

In the quarter, we generated $53 million of free cash flow defined as operating cash flow less capital expenditures and dividends paid to preferred shareholders. With excellent cash flow generation, further strengthening our balance sheet, Papa John's gains more optionality and opportunities to create shareholder value ongoing. As I previously indicated, Papa John's Q1 comp sales in North America and across our international footprint, significantly outpaced our larger pizza industry peers.

These results continue a pattern of comp sales out performance and outpaced earnings growth. Over the last 18 months, our strategy, which is focused on innovating up against all of our business platforms, including our culinary offerings, our consumer facing and back of house technologies, our customer experience and our delivery capabilities has been a significant contributor to our sustainable long-term comp sales and margin growth.

In regards to culinary innovation, I would like to start off by sharing the Epic Stuffed Crust has been a phenomenal success since its launch in North America at the end of December, has exceeded our expectations and again demonstrated the power of Papa John's new innovation mindset. Stuffed Crust lovers are ultimate pizza fans and Epic Stuffed Crust has both deepened our offerings for our existing customers, as well as attracted a new sub-segment of pizza customers.

In fact, Epic Stuffed Crust customers are significantly more likely to be new customers. Culinary innovation is also positively impacting our international business and we are starting to leverage our worldwide scale by sharing successful ideas across our network. After the successful launch of Papadias in North America in early 2020, we decided to launch Papadias in 25 international markets early this year. I'm pleased to say that they are now global favorite, and a platform that we will continue to innovate against. As we have seen since launching them in the U.S. a year ago, they are often an add-on to orders, generating incremental value without cannibalizing our core business.

Like Epic Stuffed Crust, Papadias are built on Papa John's premium dough and better ingredients, better pizza positioning. This premium positioning means we rely less on discounting to engage our customers. We have been able to drive a large increase in new customers without having to give our food away. This has significantly contributed to higher margins and better unit economics.

Now let me turn to our innovation around our digital platforms. Over the past 12 months, we have added nearly 11 million new customers on digital channels alone. These are incredibly valuable customers as we're able to engage them with targeted offers that drive incremental ticket, which drives higher margins and more transactions through higher frequency. In 2001 Papa John's was the first national pizza delivery brand to launch online ordering in all of our restaurants. We have seen consumers migrate toward digital channels steadily over the past 20 years. This dynamic has accelerated over the past year as consumer behavior has evolved throughout the pandemic. Last quarter, our percentage of digital orders rose above 70% compared to just 62%, two years ago.

Digital channels naturally facilitate high impact loyalty programs. We continue to see a growing share of transactions. Now nearing 50% come from Papa Rewards, loyalty members. In addition to higher transaction sizes and gross margins associated with better targeting of offers and promotions, loyalty members are also more engaged and much more likely to be repeat customers. Another way that we are leveraging technology is through our integrated partnerships with the major third-party delivery aggregators in the U.S., which provide incremental and profitable transactions.

In fact, our sales through aggregators increased over five times year-over-year in Q1, contributing a sizeable and accelerating portion of profitable comp sales growth in North America. Papa John's strategy with respect to channels is simple. We want to be where our customers are. This philosophy was beside – behind our decision to go digital 20 years ago and to partner with aggregators two-years ago. Aggregators provide an important value proposition for many consumers, especially around convenience and discovery. And we want to help facilitate their needs regardless of where they order.

In addition to double-digit comp sales, last quarter we also experienced a significant acceleration in unit growth. This is a testament to the fact that Papa John's unit economics are becoming more and more attractive for current and new franchisees, and therefore they are growing in their excitement to invest their capital, 80 new restaurants opened last quarter, our best first quarter for new unit growth in 20 years. With the openings last month in new countries for the brand like Cambodia and Germany, Papa John's is now in 50 countries and territories. As we have discussed previously, we spent 2020 rebuilding our development function from the ground up with new leadership and resources and a more focused strategic plan oriented around supporting existing and new franchisee partners with new data and development tools to help them invest and grow.

In parallel with this work Papa John's unit economics have been transformed over the past year and a half. As we reported at year-end, average annual unit volumes broke the 1 million level in North America in 2020, a record for the company. With the sales growth that the brand experienced in Q1, weekly per store average sales continue setting new records in North America. Strong unit profitability, not only leads the current new franchisees opening new restaurants, it also results in lower closures.

In Q1 closures in North America where the lowest this century with only three, as we discussed on our last call, the improved ROI on new units also presents a great opportunity for Papa John's to invest our capital into building new company-owned stores. In fact, we are planning to open 20 to 30 new company restaurants in 2021. This will help us grow both top and bottom line results moving forward, that it will also create more optionality as we seek out perspective and current developing franchisees to open new territories and accelerate our system's holistic growth.

Closing out the discussion on development, I am happy to say that we have started 2021 on a very positive note, with some of our largest franchisees expressing interest in growing their footprint, both domestically and internationally, as well as new investors looking to sign development deals. Our current robust pipeline of deals not only reflects the early benefits of our investment in the new development approach, but it also emphasizes the renewed strength of our brand and improving unit economics. We're confident that this momentum will lead to strong unit growth in 2021 and beyond.

Moving to operations, we are excited about the improved company restaurant operating margins, this improvement as a function of both operating leverage resulting from higher sales volumes and continued investments in operating efficiencies that have helped restaurant level margins expand dramatically. For example, last year we made a big investment in Papa call, our order taking capability that allows our store-based team members to focus on making and delivering pizzas instead of answering phones.

Papa calls, both a labor saving and revenue opportunity, delivering significant incremental average tickets compared to orders taking in the store, as well as reducing the number of drop calls resulting from putting customers on hold. We will continue to explore innovative opportunities to make our restaurants and our franchisees restaurants more productive.

I would be remiss if I did not highlight the progress that we're making towards our goal, becoming an inclusive, diverse and winning company. As I stated in the past, this culture is the foundation for the innovation that is driving all aspects of our strategy. We were especially honored to be recently recognized by Forbes as one of America's Best Employers for Diversity. Another critical element of the values-based company and culture that we're building is our commitment to being a responsible corporate citizen.

In 2019, we accelerated our journey to integrate corporate responsibility initiatives into our everyday practices. Building on our first corporate responsibility report a year ago, today we released our 2020 update, which outlines our continued progress towards setting clear corporate responsibility goals and providing transparency around our business. I encourage our shareholders and all stakeholders to review the report, which is available on our website.

As I just described our successful innovation, execution and Papa John's brand-wide transformation has all contributed to our share gains over the past six quarters. But there is no question that over the last year, changing consumer behavior and industry dynamics as a result of the pandemic have been a tailwind for pizza delivery and food delivery in general, helping accelerate our growth and transformation. As a result of last year's pandemic related lockdowns, millions of consumers have turned to food delivery and off-premise dining, which has been facilitated by digital ordering. Even as individual markets and states reopened the dine-in eating, demand has remained high.

Looking ahead, we're increasingly confident that these changes are sustainable in the long-term and that the total addressable market for delivery and carryout has grown substantially. Growing consumer demand for food delivery has been met by the industry. The shift has been underway for the past couple of years, partly facilitated and subsidized by the large aggregators, but it really took hold in the second half of 2020 as dine-in restaurants of all formats from quick service and fast casual to full-service and traditional, pivoted to offer carryout and delivery options.

This industry shift is not likely to revert as key players double down on their delivery and carryout capabilities, reinforcing the shift in consumer preferences and behaviors, but I'd also point out the Papa John's has been competing well in this broader, larger market. In fact, I believe we stand to benefit from the inherent advantages of pizza as food that delivers extremely well. We also have a big head start when it comes to digital ordering and last-mile delivery relative to the broader QSR industry.

As we look ahead, we are not yet returning to providing full-year guidance on sales or earnings. Given continued uncertainty about the trajectory of the pandemic and associated government restrictions that impact our business across the globe. However, we do want to provide some insight into what we foresee given today's current situation. Based on our strength in Q1 and continued strong April sales, even as markets begin to reopen and we left double digit comps from a year ago, we are increasingly confident in delivering year-on-year flat-to-slightly positive comp sales growth in North America in Q2.

As for development, we've gotten off to a fast start and are seeing a lot of interest from existing and new franchisees looking to invest in the brand, that being said, Q1 was a faster than expected recovery from last year's lower-end development. For fiscal 2021, we currently expect to open between 140 and 180 net new restaurants globally, which is a tremendous acceleration from last year.

I’d also emphasized that we're focused on opening profitable restaurants, set up for long-term success, not just on driving unit growth. And we'll discuss this in more detail in a moment. Most importantly, every quarter of strong results gives us more clarity around Papa John's multi-year growth trajectory. We're building a plan to achieve solid system-wide sales growth, driven by a good balance of comp sales and unit growth with strong operating leverage and free cash flow generation. We look forward to providing more color on these targets and the plan behind them over the course of the year.

And now I'll turn the call over to Ann to discuss our financial results and near-term outlook in more detail. Ann?

[Ann Gugino, Chief Financial Officer]

Thank you Rob and good morning everyone. The excitement continues at Papa John's as our financial position, further strengthened with another quarter of robust operational performance, increased cash flows and a very healthy balance sheet. This morning, I'd like to discuss each of these areas beginning with our financial performance.

As Rob discussed the record momentum in 2020 continued in the first quarter of 2021. Our innovation strategy and favorable changes in consumer behavior as well as some benefits from stimulus payments drove strong top line growth. This combined with a conclusion of temporary franchise support last year contributed to a 600 basis point expansion and adjusted operating margins yielding a $35 million or more than a threefold increase in adjusted operating income.

On a segment basis, all of our strategic business units contributed meaningfully to top and bottom line growth as we surpassed $0.5 billion in revenue for the first time in a quarter. Operating income growth was driven by domestic company on restaurants, North America franchising and international, all which achieved significant margin improvement. In North America, the reduced franchise support provided for an effective royalty rate increase of 120 basis points from the prior year. We are extremely proud of our restaurant operators who continue to execute at a very high level, driving solid restaurant profitability on great AUVs in both North America and across international.

In our company-owned restaurant segment, margins rose 240 basis points benefiting nicely from higher order sizes and transactions due largely to strong operating leverage and expense control, including in our supply chain. Continuing with the P&L, on a GAAP basis, earnings per diluted share increased to $0.82 compared to $0.15 a year ago. This includes the reduction of approximately $0.10 per diluted share in the current quarter due to income attributable to participating securities, primarily our Series B preferred stock.

In addition, current quarter results include costs related to our strategic corporate reorganization and New Atlanta office plans we announced in September, 2020. Excluding $2.6 million or $0.08 per diluted share in net reorganization costs, adjusted earnings per diluted share rose from $0.15 a year ago to $0.90 this year. For the remainder of the year, we expect to incur approximately $5 million to $10 million in further one-time cost. This is the remaining portion of the approximately $15 million to $20 million in total expenses we previously announced. As we've said, we see these costs as an investment in both the company's innovation and top line growth, as well as in our long-term corporate efficiencies.

Now I'd like to turn to cash flow and balance sheet. Strong earnings contributed to a dramatic increase in cash flow from operations from $34 million a year ago to $63 million during the current quarter. CapEx at $7 million in Q1 rose only modestly, but I would like to reiterate my comments from the last call on our expectations for capital expenditures. Leveraging the strength of our balance sheet, we continue to expect full-year capital expenditures of $65 million to $75 million focused on new store development, new technology and productivity in our restaurants and across the system.

Free cash flow jumped $53 million versus $24 million in 2020. As a result of strong free cash flow over the past four quarters, we ended Q1 with net debt of only $179 million down $150 million from a year ago. Our debt-to-EBITDA leverage ratio at quarter end was two times indicating the strength, optionality and security provided by our balance sheet.

Papa John's cash flow generation, which is an inherent aspect of our franchise business model is strengthening our balance sheet and positioning us to invest in long-term growth, while continuing to return cash to shareholders. During the first quarter, we paid a cash dividend of $10.8 million to our common and preferred shareholders. Subsequent to the first quarter on April 29th, our Board of Directors declared second quarter cash dividends of approximately $10.9 million to be paid to common and preferred shareholders. The second quarter common stock dividend is $0.225 per common share.

In the first quarter, we opportunistically repurchased 15,000 shares of common stock for $1.3 million or $84.63 per share under our previously announced 75 million share repurchase authorization. A total of 47,000 shares have been repurchased under this authorization with an aggregate cost of $4 million and an average price of $84.13 per share. As I said previously, one of our top priorities is to align our long-term capital allocation return priorities with the businesses growth, cash generating potential and strong balance sheet to maximize shareholder value.

As the long-term strategy and direction of the business settle on a positive trajectory, we have spent a good amount of time digging into our balance sheet and scenarios to optimize our capital structure by retaining strategic optionality and security. We remain committed to returning cash to shareholders, including fully utilizing the current share repurchase authorization over the upcoming quarters. At the same time, we're developing a comprehensive long-term capital allocation strategy that supports this momentum. We expect to have more to share later this year.

I'd like to wrap up by providing a few points to Rob’s comments on our long-term goals and outlook for the market. Given continued uncertainty about the pace of reopening across the world, we continue to wait before providing detailed short-term revenue and earnings guidance. However, based on the results so far in Q2, the strong sales momentum experienced with the launch of our Epic Stuffed Crust in Q1 has carried well into the current quarter.

Accordingly, as Rob indicated, we feel confident about delivering flat-to-slightly positive comp sales growth in North America in Q2, even as we lap last year’s positive 28% comp sales. We also continue to expect year-over-year margin improvement, however, given the commodity pricing outlook and the timing of certain expenses, Q2 operating margins are not expected to surpass Q1 all-time record revenue and operating leverage. In the latter half of the year, of course, we'll be lapping strong prior year results.

Also as temporary franchise support concluded at the end of Q3 last year, I'd remind you that year-over-year we will not have that benefit in Q4. Also in Q4, we will incur expenses for our annual franchisee conference, which was not held last year due to the pandemic. Before I hand it back to Rob, I want to emphasize again our excitement about Papa John's near and long-term outlook. The benefit of our team's work to create an inclusive, innovative company are reflected in our first quarter results, which sets us up very solidly for the remainder of 2021 and thereafter.

We are very excited about our future and look forward to updating you on upcoming calls. I'll now turn the call back over to Rob for some final comments. Rob?

[Rob Lynch, President and Chief Executive Officer]

Thanks, Ann. I couldn’t be more proud of our team and the great start we've made in 2021. Even as we begin to lap some very significant prior year comps in the remainder of the year, I am more bullish than ever that Papa John's innovation strategy, which has consistently driven share gains and favorable changes in both consumer behavior and the delivery and carryout market position Papa John's very well for long-term growth.

With that I'll turn the call over to the operator for Q&A.

[Operator]

[Operator Instructions] Our first question comes from Brian Bittner with Oppenheimer. Your line is open.

[Brian Bittner, Oppenheimer]

Thank you. Good morning, Rob, Ann, Steve. Congratulations on the business momentum and the transformation you guys continue to drive. The question – first question, just on the same store sales trend, I appreciate the comments on your outlook to at least have flat comps in the second quarter. I know April is giving you some good insights overall to help build this optimism into this tough lap cycle, particularly with what you're seeing in reopened markets, but other than the April trends, can you just talk a little bit more about what specifically drives your confidence, that there won't be a step back during this period of difficult comps? Do you have some more menu catalysts that you're excited about moving forward you can talk about? Are you just seeing a lot of stickiness as you scrape the data on your customers and your business that’s surprising you? Just any additional color there would be great.

[Rob Lynch, President and Chief Executive Officer]

Hi Brian, yeah it's kind of all of those things. Epic Stuffed Crust has continued to bring in new customers. We have been promoting it now for over four months and we continue to see growth in that business and we're going to continue to double down on it and continue to invest behind it. And so that over-performance in Q1 gives us confidence. It's going to continue to drive incremental sales that we hadn't had in our initial forecast in Q2.

We're also very excited about the growth in our loyalty platform. We're now at 20 million loyalty members. If you recall, two years ago we were around 12 million, so we've added about 8 million loyalty members and those are most valuable customers. They're driving higher ticket averages and higher frequency. And so as we continue to leverage, and we've gotten a lot better at leveraging our data and leveraging that resource, we have taken up some of the frequency that we believe we were going to get from those customers.

So really getting that customer engagement as well as the innovation are the two things that really give us confidence that we're going to continue to drive top line revenue growth despite lapping at 28% comp from year ago.

[Brian Bittner, Oppenheimer]

Thanks for that. A longer-term question on your optimism towards the long-term outlook, particularly on unit growth and thank you Rob, again for the color on the unit openings this year. We're obviously able to see you're improving pipeline sitting at 1,650 units very impressive. And I think 250 of these are in North America, the rest internationally. What is your outlook for that pipeline in North America? What do you think the unlock there is now that franchisees are at all-time high unit economics got to be feeling really good. How do you want us thinking about how that North America pipeline builds throughout this year and next?

[Rob Lynch, President and Chief Executive Officer]

Yeah. We believe that we will see a significant increase in that pipeline. We – our development team is currently meeting with almost every single one of our top 25 franchisees and talking about the markets that they're in and where the opportunities reside. So that pipeline does not really reflect those discussions yet. And there's never been more – since I've been here, I would say there's there hasn't been more excitement, there is right now regarding the opportunity that still exists in North America.

And in regards to holistic pipeline as we mentioned in the call, we just opened up two new countries, so those are going to start developing at scale. And we have a lot of interests coming in from the white space. If you recall, we are in 50 countries, our competitors are in 100 countries, so we have a huge amount of white space and we're entering into discussions with really sophisticated large-scale restaurant franchisees in geography that we don't currently compete in to build out those countries. So we're very bullish that pipeline will grow over the next 12 months to 18 months in a significant way.

[Brian Bittner, Oppenheimer]

Great, thank you. Congratulations.

[Rob Lynch, President and Chief Executive Officer]

Thank you, Brian.

[Operator]

Next question comes from Peter Saleh with BTIG. Your line is open.

[Peter Saleh, BTIG]

Great. Thanks and congrats on the quarter. Rob, I wanted to ask about new customers versus existing customers. It did sound like the Epic Stuffed Crust pizza drove a lot of new transactions or new customers to the brand. Can you give us a sense on how much of your – you think the comp in the first quarter came from new customers versus existing and/or maybe if you can give us a little bit of a sense, it sounds like the aggregator business was up dramatically. Is that mostly where the new customers are coming from? Any thoughts on that'd be helpful.

[Rob Lynch, President and Chief Executive Officer]

Hi Pete, so we have brought in 11 million new customers over the last year in our digital channels and that's really where we can track it most closely. And we're seeing about half of those enter into our loyalty program and our loyalty members are higher frequency, higher ticket, are most valuable customers. So a lot of our growth did come from new customers in Q1. And as we mentioned, our aggregator business was up five times.

We have said in the past that we believe that the incrementality of that business is between 60% and 65%. So those are a lot of new customers that we wouldn't have gotten had we not entered into this – these partnerships. So our frequency amongst our current customers outside of loyalty program has remained relatively flat. Our frequency amongst our loyalty program, customers has increased and a lot of new customers. So that's really the breakdown of how the comps have been generated in Q1.

[Peter Saleh, BTIG]

Great. And then just on the advertising budget, I know last year obviously, sales ballooned more than you anticipated and clearly it looks like that's continued at least into so far into 2021. Can you give us a sense on how much of the ad budget from last year that rolled into 2021 has already been spent and how much you guys still have in your back pocket to utilize for the balance of the year?

[Rob Lynch, President and Chief Executive Officer]

We – obviously 26% comps drive a lot of advertising revenue. So that we weren't necessarily budgeting for that in Q1, so there is a surplus of advertising dollars that we're going to be able to reinvest back into the business. And last year we did have a pretty significant surplus despite aggressive investment. I mean, if you recall, when we were talking, well it must've been about a year ago, we were concerned about a lot of questions I was getting there around when the franchisee We Win Together program went away and the marketing subsidization went away where we are concerned about the ability to drive growth.

And I was – it was one of the things that kept me up at night when I first got here. We have more than offset that lack of company investment in the national marketing fund with sales growth. And we're running a large surplus right now that we're reinvesting back into the business at a very accelerated rate. So all of this sales over delivery is generating more marketing dollars than we had in our plan and we're reinvesting that back into the business.

[Peter Saleh, BTIG]

Thank you very much.

[Rob Lynch, President and Chief Executive Officer]

Got it. Thanks Pete.

[Operator]

And the next question comes from Brian Mullan with Deutsche Bank. Your line is open.

[Brian Mullan, Deutsche Bank]

Thank you. Rob, question around the plans to build 20 to 30 company-owned stores this year, I think everyone on the call understands why you plan to build those stores. It makes a lot of sense, but perhaps you could explain how you are choosing where to build those company-owned stores this year and your strategy as you choose locations. And then related to that, should we expect company-owned store building to be a multi-year endeavor kind of bridging the gap to a time when maybe it is almost entirely franchisee led at some point in the future.

[Rob Lynch, President and Chief Executive Officer]

Thanks. Here's the reality, we are a franchise system. Our entire global or international network is 100% franchise. Obviously in the United States, we feel great about our company-owned restaurants, but really what we're trying to accomplish is we're trying to build the model that can help accelerate franchise development domestically.

So we are going into our highly penetrated markets like Atlanta, Louisville, St. Louis, Orlando, where we have a lot of restaurants and we are looking where we have gaps in those markets and where our drive times are the longest, and where our number of households proud, exceeds kind of what we think is the optimized number. And we're looking for great real estate where we can fill-in and build restaurants that we're forecasting.

The next three restaurants that we have we're forecasting to be, that we're going to build above our current average AUV. I mean, we're not going in and looking at just popping in restaurants that might or might not succeed. We are going in and building restaurants that can improve our customer service, but also generate profitable returns right out of the gate. And by doing that, we're going to leverage that data and that model to help supplement the conversations we're already having with our franchisees around building out their markets in a similar way.

When I first got here, I think I said this in the past, when I first got here, I was told that we were built out in North America and I said, well why is that when our competitors have almost 2X the number of restaurants. He said, well, you know, our maps are all filled-up. And I said, well, we need new maps. And we did, we went and built the technology to build new maps. Amanda Clark came in from Taco Bell and she has built an amazing team and they are remapping the entire country. So we need to work with our franchisees to build out their markets.

And yeah, once we built that model, is there an opportunity for us to refranchise company restaurants and get to a more of a franchise model domestically, that's definitely a possibility. We're continuing to leverage the optionality we have with our company restaurants when it makes sense for us to see franchisees who want to come in and develop.

[Brian Mullan, Deutsche Bank]

Okay, thanks. And then just pivoting – just a question for you on the UK business. Could you just speak to how that business is doing today? And in addition, it'd be great to get your perspective on where that market is and its unit growth life cycle, that it's been a very solid unit grower for Papa John's for many years. Maybe in baseball terminology, like what inning you think you are there in the UK in that core market.

[Rob Lynch, President and Chief Executive Officer]

Yeah, the UK is our best market right now, hands down. The UK had our highest comps last year and has our highest comps this year. So that market is just absolutely on fire and we still see a significant amount of development growth. We think we can probably build 2X the number of restaurants in the UK that we have today. So not only do we believe in the continued comp performance, but we also believe there's a lot of opportunity to build primarily outside of London up in the Northern parts of the country where we're relatively undeveloped, still a lot of opportunity there.

[Brian Mullan, Deutsche Bank]

Thank you.

[Rob Lynch, President and Chief Executive Officer]

Thank you.

[Operator]

[Operator Instructions] And next question comes from Alex Slagle with Jefferies. Your line is open.

[Alex Slagle]

Thanks, good morning and congrats, good to see the momentum. Had a question still on the people side, I mean, you've hired over 30,000 new team members system-wide many of whom probably came from other industries that were temporarily hit by COVID. But now we see a lot of these industries scrambling to regear or hire people back with bonuses to get the staff back. And I know you've been very generous with rewarding your staff during the pandemic, but interested to get your perspective on the system's ability to continue hiring and retaining team members at the rate necessary, given these records sales volumes as the labor battle sort of heats up here.

[Rob Lynch, President and Chief Executive Officer]

That was great question, Alex. There's no question that labor is a limited – in limited supply at this point across most industries, not just ours. But as you mentioned, we have done our best to maintain to be an employer of choice for all of our employees, both at the corporate level, as well as in the stores. And we've been working with our franchisees very closely to help them support being an employer of choice as well.

And it starts with the higher sales at the restaurant. I mean, frankly the primary gap in labor is with the drivers and, but the more volume you're doing at every restaurant, the more money each of those drivers can make. So that has been a good retention tool for us, simply our growth and the increased pay that our employees are making.

Our drivers makes significantly more than the average minimum wage in whatever market you look at. So we've been able to kind of retain drivers through that. And we've also offered incremental benefits around healthcare, all of our employees receive telehealth, paid for by our company, we've given some special frontline bonuses to our restaurant workers. So our goal is to continue to be an employer of choice and treat our employees the way that is consistent with maintaining them.

In terms of going out and getting more, I mean, we are hiring. We could hire 10,000 more employees right now. So we are always looking for great talented people who want to come and be a part of something that's growing and something where we have been taking care of these communities for the last year, and a lot of our employees take pride in that. So it's really a kind of a family environment in those restaurants that we want to bring in people who want to be a part of that.

[Alex Slagle]

And following up on this, is there an impact on your commissary business to talk about just the staffing and the facilities and the drivers there? Just trying to think about any incremental labor-related costs that might show up in the commissary margin or that gets passed on to the franchisees?

[Rob Lynch, President and Chief Executive Officer]

Yeah. I mean, we've been – it's a system-wide expense. Obviously, our supply chain is funded by our entire system. So it doesn't all hit – not all of that hits our P&L. It is spread across. Obviously, we own 600 restaurants domestically. So that's about 20% of the system. And so we incur about 20% of that increased inflation. But our team has been really good about keeping the supply chain going. As I mentioned in an interview I did last night or this morning, our suppliers are starting to be challenged in being able to maintain levels of supply because of their labor shortages. But for us, we really haven't seen a significant wage inflation situation to date given we haven't – we've been able to retain our employees in a fairly disproportionate manner.

[Operator]

Thank you. Our next question comes from Alton Stump with Longbow Research. Your line is open.

[Alton Stump, Longbow Research]

Great, thanks. Good morning, and congrats on the great quarter. I just wanted to ask as far as your comments about new franchisees versus existing opening stores. I have ballpark estimate that you give us as to how [indiscernible] next couple of years do you think of new builds here at North America will come from new versus existing franchisees?

[Rob Lynch, President and Chief Executive Officer]

Yeah. Hi, Alton. We want to win with our existing franchisees. I mean, our goal would be to get our existing franchisees to fill up all of these markets, open up white space, and it would be – the ideal scenario is that we never have to go outside our system to achieve the unit growth that we believe we are capable of achieving. However, where there are opportunities where for whatever reason a franchisee in a market is not interested in developing, we are actively pursuing other franchisees.

And over the course of this year, we are going to make some big announcements. We're already in late stage discussions with prospective franchisees to come in and open up new territories and build out territories where we think there is a lot of opportunity. So I think the ideal scenario is probably about an 80-20, where about 80% of our growth is coming from current existing franchisees, but there is a lot of demand to get into our system right now externally.

And if we are unable to achieve our development objectives with our existing franchisees then we'll start opening up more opportunities for prospective new franchisees to come in.

[Operator]

Thank you. Our next question comes from Eric Gonzalez with KeyBanc Capital. Your line is open.

[Eric Gonzalez, KeyBanc Capital]

Hey, thanks. Good morning, and congrats on the really strong performance. I think you said three quarters of your business is delivery, your largest competitor is talking that carryout as an opportunity since it had underperformed delivery over the last year. We should all agree that the overall shift toward convenience is not going to change, but do you think your low carryout mix might actually be a relative disadvantage going forward given the low carryout mix? What do you think carryout opportunity as you continue to build out the footprint?

[Rob Lynch, President and Chief Executive Officer]

Yeah. I don't know, I mean, why that would be a disadvantage. I mean, the aggregators are growing at 100%, delivery is becoming a much bigger part of the industry, and we're one of the top delivery operators in the country. So we offer carryout. We support our carryout business. But we are not pushing customers into carryout by discounting our carryout business. I mean, that's really the biggest difference. It's not like we don't offer the same level of service of carryout as everyone else, we're just not going to discount our product.

We have been focused on growing our sales by allowing customers to self-select and to Better Ingredients Better Pizza on our core business and all of our new innovation. We've significantly reduced the amount of discounting in this business. And so when – I think whenever – when other people talk about driving the carryout business, they're going to give incentives to do that, that's not in our strategy, and I don't see that as a disadvantage at all.

[Operator]

Thank you. Our next question comes from Dennis Geiger with UBS. Your line is open.

[Dennis Geiger, UBS]

Great. Thanks for the question. Rob and Ann, I appreciate the commentary on the detailed targets on development for the year. Just wondering if you could talk a bit more about some of the puts and takes there for the year and I guess, more importantly, looking ahead, it sounds like the pipeline is obviously strong in the U.S. and international markets, trends are clearly up into the right in the right direction. Just curious as we think about the timing of those opens, how much of it is sort of the macro uncertainty in international markets maybe has an impact over the medium – near to medium term? And even in the U.S. despite the strong results and the benefits and the tailwinds you've seen over the last year, how much of the uncertainties around wages and other factors may be kind of play into again some of the near to medium-term decisions that your franchisees are going to make? Thank you.

[Rob Lynch, President and Chief Executive Officer]

We gave some color around what we think we can do this year, 140 to 180 new units, our net new units, and that's a combination of both new openings as well as how many we close. And one of the greatest signs of the health of our system right now is a complete lack of closures. In Q1, we closed three restaurants. We haven't done that in over 20 years. So we believe that we are opening restaurants today.

We have the technology and ability to choose sites and model out what we believe the sales are going to look like so that we are opening up good profitable restaurants. And so we will need less openings than historically to deliver the same net new unit growth if we have less closures. And so that's what we're focused on. So we may not go out right away and open up 400 restaurants and close 200 for a net 200, but we are going to go out and open up between 140 and 180 restaurants while we're closing very few restaurants.

And so it's going to be a more stable growth rate, but I see it growing year-on-year for the foreseeable future. There's not like kind of a cap on where we think we can go in terms of the number of restaurants per year. It's really just about us working with our franchisees to find real estate and build out a model that's sustainable. It's a better utilization of capital, doesn't do any one good to open up an unsuccessful restaurant.

So we are going to have a more steady growth rate than maybe in years past, but we see it – we think we can do 140 to 180 this year and that's going to grow next year. We don't have a lot of concern about the instability of the markets driving development down below what we think we're going to do.

[Operator]

Thank you. Our next question comes from Chris O'Cull with Stifel. Your line is open.

[Chris O’Cull]

Hey, thanks. Good morning, guys. Rob, how are you thinking about product innovation for the balance of the year? I mean, do you expect to just continue extending innovation around the Epic Crust and Papadias or is there an opportunity to introduce another new platform or category to the menu?

[Rob Lynch, President and Chief Executive Officer]

Yeah. That is a question that we have as a team almost every week. I mean, Epic Stuffed Crust has done way better than we had forecasted. We had already planned to have launched new innovation already this year. But when you're doing the kind of sales that we're doing and it's being driven by an initiative that you're promoting, it's really hard to take that thing off of promotion.

So we are looking at a lot of different models whether it is bringing a new item in the short-term or launching a new platform over a bit of a longer term or potentially moving into a space where we haven't really been before where we're promoting two items at once. So we have the innovation. It's ready to go. We're very excited about it. But to pull the plug on something that's doing as well as Epic Stuffed Crust just doesn't seem like the right strategy right now.

But we have built – it really affords us the greatest luxury of continuing to build the innovation pipeline without needing it. So we've got a lot of great things in the hopper that are ready to go, and we're definitely going to have some new stuff coming this year. But right now, I can't disclose exactly when that's going to come.

[Operator]

Thank you. Our next question comes from Brett Levy with MKM Partners. Your line is open.

[Brett Levy, MKM Partners]

Great. Thanks for taking the call, kudos on the sales. You mentioned a few different items on the G&A front, convention and the headquarters move. Can you walk through how you're thinking about the puts and takes whether it's the stepped-up investments, the return of certain costs where your leverage opportunities exist for this year, and also any early thoughts into 2022? Thanks.

[Ann Gugino, Chief Financial Officer]

Sure. So certainly there is some noise in G&A, as we talked about. In particular, this year, we have the restructuring cost at about $4 million and then that's offset by reductions in the We Win Together program from last year. So as I mentioned in my remarks, we still have about $5 million to $10 million of incremental costs associated with the Atlanta headquarters opening. So we will experience that for the balance of the year.

What I would say though, if you take out that noises underlying, kind of the Phase 3 of G&A is growing in that low-single-digits, which is really just kind of merit and inflation. So I would use that kind of as your baseline and then layering on the re-org. In terms of timing, what we are pointing out there is just a reminder that the We Win Together program and the benefit that we're seeing from last year that really takes us through Q3.

So we don't have that benefit in Q4. And then in addition to that, we are bringing back our franchisee conference in Q4, which will be an incremental expense year-over-year because we didn't have that last year from the pandemic and that's about $2 million to $2.5 million.

[Operator]

Thank you. Our next question comes from Jim Sanderson with Northcoast Research. Your line is open.

[Jim Sanderson, Northcoast Research]

Hey, thanks for the question and congratulations on a fantastic quarter. I wanted to dig in a little bit more following on to the discussion of international development. Maybe if you could talk about the development taking place in Germany, I think that's about 250 units over seven year term? And if that will eventually lead to strengthening of development in some of the other top European markets and maybe you can compare the AURs you're expecting out of Germany compared to what we see in the U.S.?

[Rob Lynch, President and Chief Executive Officer]

Yeah. So we have three units that have opened in Germany. They're being opened by our franchisee that has really build-out Russia. So it's a gentleman who knows how to build out a new territory, and we have a lot of confidence in his ability to come into Germany and be successful. Continental Europe is a huge opportunity for us. As we've discussed, the U.K. is performing extremely well over the last five years. We've got out Spain. But really outside of the U.K. and Spain and restaurants in Luxembourg, we really have a lot of white space opportunity in France, Italy, big geographies that we haven't tapped into yet.

So we think that there is a lot of opportunity. And being successful in Germany, which we have a lot of confidence in, will then seed our ability to either move into those other countries with those franchisees or bring in new franchisees that are already operating restaurants in those countries to open up Papa John's. So lots of upside in Continental Europe, we still have a lot of upside in markets that our competitors are fairly penetrated in. We don't have any restaurants in Australia yet. We see that as a huge opportunity. We don't have any restaurants in Brazil.

So big markets, they can support the numbers like you're talking about, 200 to 250 restaurants that we still have yet to move into, so all of that is upside to the pipeline numbers that are currently in the forecast.

[Jim Sanderson, Northcoast Research]

And just a quick clarification, should I expect those unit volumes to be comparable to what we see in the United States?

[Rob Lynch, President and Chief Executive Officer]

Our international unit volumes fluctuate dramatically. Our highest AUV actually is in Chile where we're performing at an extremely high level. But you have markets that do significantly less, but they don't need to do as much because the labor environment is different, the real estate environment is different. So it really is a market-by-market dynamic on a view like an international AUV is almost a misnomer because every market has very unique dynamics.

In Germany, where you have relatively high real estate, relatively high labor, yes, I mean, for us to be successful there, we're going to need to have AUVs that are in the range that we're seeing in the United States. That's what we will need to be successful.

[Operator]

Thank you. Our next question comes from Lauren Silberman with Credit Suisse. Your line is open.

[Lauren Silberman, Credit Suisse]

Thank you and congratulations on the great results. Just a quick follow-up on labor, to what extent are you and could you leverage your partnership with DoorDash to complement your delivery driver fleet for orders through direct Papa John's channel? And then my primary question is about the franchisee relationships. Rob, you've been at the company a little over 18 months transformed the strategy economics and just frankly put up incredible results. So can you speak to how franchisee sentiment, communication and your relationship has evolved from when you started to where we are now?

[Rob Lynch, President and Chief Executive Officer]

Yeah. So to your first question – and hi, Lauren it's great to hear from you. The first question is, yes, we are absolutely partnering with our aggregator partners to leverage their labor force. It's one of the core pieces of rationale for us to have integrated them so tightly into our systems. So most folks are familiar with the capability DoorDash Drive, we have full integration with that capability. And I think we're a top five customer for DoorDash now and leverage them to a huge extent. So that is part of our plan. And it couldn't come at a better time.

So when we are running short on labor, particularly on a Friday or Saturday night and our peak periods, we are leveraging DoorDash Drive in a big way, and we will continue.

On the franchisee relationship, I can honestly say, this is the best collaboration I've ever seen, and I've seen some really good collaboration. We had great franchisee partnerships at some of my other previous companies. But right now, we have gotten past that honeymoon stage where we are trying to build trust. There's always – it takes a long time to build trust and a short time to lose it. So I'm not saying that we're still not focused on that type of relationship. But I would tell you that the franchisees are bought into our plan.

Their units are generating more revenue and more cash flow than they ever have. So that helps. And they deserve it, because they made it through some really tough times a couple of years ago. But that is the foundation, but it's more than that. I mean, we've partnered with them through the pandemic to help work through challenges that we had never seen before. To help them understand what the government regulations that were coming down were and how that will help them keep their employees staffed, the restaurant staffed and their employees taken care of.

So the pandemic really helped bring our system together. And the success that we've had as a result of some of the initiatives that we've put in place has really – can yield that relationship and created a situation now where when we meet in our franchisee advisory council meetings, we're talking strategy. There is a lot less debate about one-off things. We're talking about high level things on how we can all grow together moving forward. So the franchisee relationship is as good as I could have hoped 18 months ago coming on.

[Operator]

Thank you. Our next question comes from Todd Brooks with CL King and Associates. Your line is open.

[Todd Brooks, CL King and Associates]

Hey, thanks for taking the question and congratulations on the momentum in the business. Ann, I know you spoke about kind of details about capital allocation, further details coming later this year. But could you or Rob speak to just the philosophy around the model, the highly franchise nature of it, you did mention that leverage is down to two times. So just thoughts on – kind of additional thoughts on what type of leverage you could see this business carrying the fuel whatever pivots and new programs you're looking to make from a capital allocation standpoint that would be helpful? Thank you.

[Ann Gugino, Chief Financial Officer]

Sure. I mean, our cash flow generation just continues to strengthen our balance sheet position, which just it adds that flexibility to invest in long-term growth and also continuing to return cash to shareholders. So we're still planning CapEx in the range of $60 million to $75 million to accelerate our momentum. It is really in three key areas. We talked about the new store development technology to continue to drive innovation and then capabilities to drive additional productivity.

So we expect to generate good returns on these investments, and that would be our top priority, as we stated previously, is to deploy capital for high returning investments in the business first and foremost. And then generally speaking in one form or another, we'll return excess cash to shareholders over the course of time. So we don't have an intention long-term of sitting with a huge amount of excess cash in the balance sheet. We do plan to put it to work.

In terms of leverage, we certainly have capacity to go up beyond the two times. And we'll provide some more color on where we think that sweet spot is in future quarters.

[Operator]

Thank you. Our last question comes from Andrew Strelzik with BMO. Your line is open.

[Andrew Strelzik, BMO]

Hey, good morning. Thanks for taking the question. I just wanted to ask another one on international unit growth. And now you mentioned the number of countries you're in versus some of the peers and what's going on in Germany. I guess, within the pipeline that you have internationally right now and just broadly as you think about the next several years, how do you think about the new market dynamics there and entering those new markets versus fortifying the existing markets? How should we think about that split kind of evolving over time just as we look at the opportunity to both enter new markets as well as grow some of the markets where you might be – you kind of under-penetrated? Thanks.

[Rob Lynch, President and Chief Executive Officer]

It's a great question, Andrew. We definitely see opportunities in both instances. I mean, you look at geographies, you look at markets like China where we only have 200 restaurants. Our competitors have significantly more restaurants there. We think we can get to 1,000 restaurants in China. So when you start thinking about some of these markets, the big markets that we're still under-penetrated in, we're definitely working with those franchisees to move faster and grow those markets as well as open up new markets.

Now one thing I will tell you that is really interesting, a really interesting dynamic that has happened as a result of the pandemic. In markets like China, the operators used to believe, and in lot of the Middle East countries, the operators used to believe that they needed to open big restaurants with big dining rooms because of the cultural norms in those markets and that obviously costs more than our delivery-based restaurants here in the U.S. That dynamic is changing rapidly.

So now in almost every market, our franchisees are opening delivery delco units almost exclusively. And what that's going to do is that's going to reduce the amount of capital necessary to open new stores. And so we are more bullish today than ever on the rate of development internationally, especially in the market that used to really focus on those dine-in units, moving to a delco model, they can open a lot more restaurants for the same amount of capital, and that's going to benefit everybody. And do the similar revenues with the change in the behavior of the consumers.

[Operator]

Thank you. And I'd now like to turn the call back over to Rob Lynch for closing remarks.

[Rob Lynch, President and Chief Executive Officer]

Well, thank you all for joining us again and for your questions this morning. We hope that all of you are as excited as we are about the future of Papa John's. This first quarter was a very important quarter for our brand. It's further proof of our sustainable winning strategy, and frankly, the lasting change in our industry that we are competing in. All of these things position us extremely well for long-term growth.

So we look forward to reporting back to you on our continued momentum and outlook, including our long-term plan and capital allocation strategy that Ann mentioned today. I wish all of you well. Please stay safe. I look forward to talking to you again soon. Thank you again.

[Operator]

This concludes today's conference. Thank you for participating. You may now disconnect.