Papa John’s International, Inc. — Form 10-Q Summary
Business context and reporting period
The filing covers the quarter and six months ended June 29, 2014, compared with the periods ended June 30, 2013. Papa John’s operated 4,487 restaurants at quarter-end, including 731 company-owned and 3,756 franchised locations across the United States and 37 international countries and territories. Revenue was generated from company-owned restaurants, franchise royalties and fees, commissary sales, and related services.
Key financial metrics
| Metric | Three months ended June 29, 2014 | Year-over-year change | Six months ended June 29, 2014 | Year-over-year change |
|---|---|---|---|---|
| Total revenue | $380.9 million | 9.1% | $782.2 million | 11.0% |
| Operating income | $27.0 million | 0.2% | $59.0 million | 4.3% |
| Income before taxes | $26.2 million | (1.4%) | $57.6 million | 1.3% |
| Net income attributable to the Company | $16.7 million | (2.3%) | $36.1 million | (1.1%) |
| Diluted earnings per share | $0.40 | $0.01 increase | $0.85 | $0.04 increase |
| Net cash provided by operating activities | Not separately provided | — | $54.6 million | 15.5% |
| Free cash flow | Not separately provided | — | $28.3 million | 30.3% |
Reported operating margin was approximately 7.1% for the quarter and 7.5% for the six months, compared with approximately 7.7% and 8.0%, respectively, in the prior-year periods. The effective tax rates were 32.0% for the quarter and 33.4% year to date.
At June 29, 2014, cash and cash equivalents were $20.0 million, total assets were $485.2 million, and total liabilities were $368.2 million. Revolving credit debt was $210.0 million, compared with $157.9 million at December 29, 2013. Approximately $67.5 million remained available under the $300 million facility, and the Company was in compliance with its debt covenants. The leverage ratio was 1.5 to 1.0 versus a maximum permitted 3.0 to 1.0; the interest coverage ratio was 4.9 to 1.0 versus a minimum required 3.5 to 1.0.
Material changes versus the prior comparable period
- Domestic company-owned comparable sales increased 7.5% in the quarter and 9.5% year to date; North America franchised comparable sales increased 5.4% and 7.2%, respectively.
- International comparable sales increased 8.6% in the quarter and 7.6% year to date on a constant-dollar basis. International restaurant count increased to 1,201 from 1,010 in the prior-year quarter-end comparison.
- Domestic company-owned restaurant income before taxes increased $2.5 million for the quarter and $4.8 million year to date, despite higher cheese and other commodity costs.
- Domestic commissary income before taxes declined $2.8 million for the quarter and $2.5 million year to date. Commissary margin declined to 6.0% from 7.9% for the quarter and to 6.8% from 7.9% year to date, reflecting commodity costs, insurance claims, and ongoing operating initiatives.
- Net interest expense increased because of higher average debt and a higher effective interest rate. The six-month period in 2013 also benefited from a reduction in the redemption value of a mandatorily redeemable noncontrolling interest.
- Share repurchases totaled $63.3 million during the first six months, reducing weighted-average diluted shares by 6.1% year over year and supporting the increase in diluted EPS.
- The Company paid quarterly dividends of $0.125 per share during the second quarter. Subsequent to quarter-end, the Board approved a 12% increase in the annual dividend rate to $0.56 per share and declared a $0.14 third-quarter dividend.
Guidance, outlook, commentary, risks, and unusual items
- The FOCUS point-of-sale system had been installed in 383 restaurants at quarter-end, with most installations expected by year-end 2014. Management projected approximately $5.0 million of 2014 pretax impact, or $0.08 of diluted EPS, compared with 2013. FOCUS reduced pretax income by $0.9 million in the quarter and $1.1 million year to date.
- Excluding FOCUS rollout costs, pretax income increased 1.9% in the quarter and 3.2% year to date; these are non-GAAP measures.
- Management expected full-year 2014 domestic commissary profit margin to approximate 2013, although quarterly margins were lower.
- The FOCUS financing program includes Company guarantees for certain franchisee loans. The guarantee is limited to the greater of 10% of all loans or 100% of higher-risk loans. No liability had been recorded at quarter-end because the rollout had just begun.
- The Company entered into a $50 million forward interest-rate swap in May 2014, effective December 30, 2014, in addition to an existing $75 million swap. A 100-basis-point increase in interest rates was estimated to increase annualized interest expense by approximately $850,000.
- Cheese prices remained a significant commodity risk. The filing reported actual average block prices of $2.212 per pound in the first quarter and $2.131 in the second quarter, versus $1.662 and $1.784 in the comparable 2013 periods. Full-year 2014 projected average cheese price was $2.079 per pound.
- A conditionally certified collective action, Perrin v. Papa John’s, involves alleged delivery-driver mileage and expense reimbursement violations. Approximately 3,900 drivers had opted in from a potential class of 28,800, and approximately 15,000 additional plaintiffs could be added from five states. The potential loss could not be reasonably estimated and a negative outcome could materially affect the Company.
- Other principal risks include food and commodity costs, supply-chain disruption, competition, international operations, franchisee credit performance, interest and currency rates, information technology and data security, and execution risks associated with the FOCUS rollout. Management stated that there were no material changes to the risk factors disclosed in the 2013 Form 10-K.
- The Company adopted no new revenue-recognition standard during the period. It expects to adopt ASU 2014-09 in 2017 and currently does not expect a significant impact.
Most important facts for investors to verify
- Whether strong comparable sales continue to offset commodity inflation and lower commissary margins.
- The pace, cost, operational effects, and franchisee adoption of the FOCUS system rollout, including any guarantee obligations.
- Debt-funded share repurchases, remaining credit availability, covenant headroom, and sensitivity to higher interest rates.
- The potential financial and operational impact of the Perrin litigation and any additional employment or delivery-driver claims.
- Whether international growth, particularly in China and the United Kingdom, continues to improve profitability.
- The sustainability of dividend increases and share repurchases relative to operating cash flow and capital expenditure requirements.