Papa John’s International, Inc. — Q3 2011 Form 10-Q
Business context and reporting period
Quarterly report for the three and nine months ended September 25, 2011, compared with the periods ended September 26, 2010. Papa John’s operated 3,780 restaurants at quarter-end: 623 company-owned and 3,157 franchised, across all 50 states and 32 countries.
Key financial metrics
| Metric | Q3 2011 | Q3 2010 | 9M 2011 | 9M 2010 |
|---|---|---|---|---|
| Total revenue | $305.7 million | $273.1 million | $911.7 million | $839.6 million |
| Operating income | $17.0 million | $13.8 million | $63.3 million | $64.5 million |
| Net income attributable to Papa John’s | $11.1 million | $7.8 million | $39.7 million | $37.9 million |
| Diluted EPS | $0.44 | $0.30 | $1.55 | $1.42 |
| Operating margin | 5.5% | 5.0% | 6.9% | 7.7% |
| Cash flow from operations | Not provided for quarter | Not provided for quarter | $84.3 million | $62.2 million |
| Free cash flow | Not provided for quarter | Not provided for quarter | $63.7 million | $33.0 million |
- Revenue increased 11.9% in the quarter and 8.6% year to date. Domestic company-owned comparable sales increased 6.3% in Q3 and 5.0% year to date; North America franchised comparable sales increased 4.9% and 3.6%, respectively.
- Domestic commissary revenue rose 17.0% in Q3 and 12.1% year to date, primarily reflecting higher commodity selling prices, particularly cheese, and increased volumes.
- Restaurant operating margin for domestic company-owned units declined to 17.4% in Q3 and 19.1% year to date, primarily because of higher cheese, wheat and meat costs and increased advertising expense.
- Net interest expense declined to approximately $0.1 million in Q3 and $0.6 million year to date, versus approximately $1.2 million and $3.4 million in the comparable periods, reflecting lower debt and interest rates.
- Cash and cash equivalents were $23.7 million at September 25, 2011, versus $46.2 million at December 26, 2010. Total assets were $386.3 million.
- Long-term debt was $50.0 million, down from $99.0 million at year-end 2010. The $175.0 million revolving facility had $111.6 million of remaining availability, net of specified letters of credit.
- Leverage was 0.5 to 1.0 against a maximum permitted 2.5 to 1.0; interest coverage was 5.1 to 1.0 against a minimum required 3.5 to 1.0. The company reported compliance with all debt covenants.
Material changes versus the prior comparable period
- Q3 net income attributable to Papa John’s increased 41.7%, while nine-month net income increased 4.6%. Diluted EPS increased 46.7% in Q3 and 9.2% year to date, aided by lower share counts from repurchases.
- Income before taxes, excluding the prior-year BIBP variable-interest-entity impact, increased 28.0% in Q3 and 13.0% year to date.
- The domestic company-owned restaurant segment declined $1.2 million in Q3 and $3.0 million year to date because commodity inflation more than offset sales growth.
- North America franchising income increased $1.3 million in Q3 and $3.5 million year to date. International results improved by $1.6 million in Q3 and $3.3 million year to date, although the international segment remained at a year-to-date operating loss of approximately $0.8 million.
- BIBP Commodities’ cheese-purchasing arrangement was terminated in February 2011. BIBP contributed no material operating impact in the current-year periods, compared with a $0.7 million pretax loss in Q3 2010 and $5.5 million pretax income in the first nine months of 2010.
- The company repurchased $49.6 million of common stock, or approximately 1.6 million shares, during the first nine months. Through October 26, 2011, it repurchased an additional 252,000 shares for $7.7 million; $29.5 million remained authorized.
Guidance, outlook, risks and unusual items
- The filing does not provide formal earnings or revenue guidance. Management expected higher national marketing expenditures under the 2011–2013 National Marketing Fund Agreement and continued international and franchise unit growth.
- Management estimated a 2011 full-year average cheese block price of $1.785 per pound based on October 26, 2011 futures prices, versus $1.503 in 2010. Cheese historically represented approximately 35% to 40% of total food costs.
- Other general expenses included a $782,000 charge for rentals, taxes and insurance related to certain former Perfect Pizza UK leases after Perfect Pizza entered administration. The company could not reasonably estimate additional potential liability for remaining locations; the maximum undiscounted rental exposure under approximately 40 leases was estimated at $2.5 million, excluding the recorded charge.
- The company identified commodity inflation, fuel and labor costs, competitive pricing, consumer demand, food safety, legal claims, international operations, foreign currency and interest-rate exposure as material risks.
- PJUK had $21.1 million of net investment and $14.7 million of allocated goodwill at quarter-end. Management stated that unsuccessful improvement initiatives could result in future impairment charges.
- Tax settlements produced income tax benefits of approximately $1.0 million in Q3 and $1.6 million year to date. The effective tax rate may fluctuate based on tax settlements and other discrete items.
- Disclosure controls and procedures were evaluated as effective, and management reported no material changes in internal control over financial reporting.
Most important facts for investors to verify
- Whether commodity costs, particularly cheese, continue to pressure company-owned restaurant and commissary margins.
- The sustainability of comparable-sales growth and franchise unit expansion, including the effect of promotional incentives and royalty rebates.
- The recovery trajectory of the international segment and the potential for PJUK goodwill or long-lived asset impairment.
- The remaining Perfect Pizza lease exposure and any additional obligations arising from the UK administration process.
- The effect of ongoing share repurchases on cash balances, leverage and per-share results.
- Whether the company maintains compliance with revolving-credit covenants and preserves sufficient liquidity as capital expenditures and repurchases continue.