A common theme for this earnings season is that top line sales trends remain strong, but nearly every management team has underestimated the impact of inflation on margins and earnings.
Here is a look at what PZZA was saying about their most important commodity during the company conference call on 2/23/11. Keep in mind that cheese prices went up 20.86% during the first quarter of 2011.
Confirming guidance (but they need to maintain sales trends)- We are reaffirming our 2011 earnings per diluted share guidance range of $2 to $2.12, as we expect the favorable impact of early year sales results to substantially mitigate the unfavorable impact of currently projected commodity cost increases, most notably cheese, throughout the remainder of the year.
Change in accounting this quarter - As Jude will discuss in more detail, we reached an agreement with our domestic system regarding the national marketing fund contribution rate for 2011 through 2013. In connection with this agreement, we eliminated the year-end BIBP deficit of approximately $14.2 million and substantially all franchisees have executed a cheese purchase agreement. As a result, future differences in cheese costs and prices paid by franchisees will be reported as changes in a payable to or receivable from franchisees as opposed to income or expense in our financial statements. And accordingly, we intend to eliminate pro forma reporting for the impact of BIBP beginning in Q1 of 2011.
Question - Going back and doing the math, it looks like it's around a three to four basis point change in operating margin for every $0.01 change in the price of cheese. What I'm wondering is, in this environment is that still relevant to think that a $0.01 increase in cheese prices equates to a certain dollar amount of operating margin? And if so, I was wondering if you could possibly quantify for us the comparable sales level that would be required to make up, say a 40 basis point decrease in margin, operating margin resulting from a $0.10 to $0.12 increase in cheese prices in '11, if that were to be the case?
Answer - John H. Schnatter: Yeah, it correlates exactly, mathematically the way that you described it, if you lived in a linear world. Fortunately we do not live in a vacuum. Fortunately we do not live in a vacuum. So, with inflationary pressures on all the restaurant chain while cheese is going up and we don't like it, so are our other commodities and we see price increases in the restaurant segment that should offset these costs, or at least to your point, mitigate it along with the great top-line sales we're having. And David, I don't think we'll be any more specific than that relative to how the year has started off since it is the current quarter that we're in.
Question - Can you kind of give us an outlook on where you guys think the competitive environment is going here with cheese costs? Do you see the other guys backing off of these deep, deep discounts and that's a benefit to you, or do you think that you're still going to be competing on very, very discounted pizzas out there for the foreseeable future even with cheese where it's at?
Answer - John H. Schnatter: I've been doing this for 26 years. We've seen a lot, if not everything. We've learned that if we just run our business the way it's supposed to be run, we do quite well with our brand and our positioning and the quality of our product. With that being said, I think 2010 was unprecedented in that I've never seen two of the bigger competitors change their whole product and spend the kind of marketing dollars they spent and run the kind of discounting they run and us still have positive traffic. So 2010 in our eyes was a litmus test, for the brand is very solid.
Howard Penney
Managing Director
