Papa John’s International, Inc. — Form 10-Q Summary
Business context and reporting period
Quarterly report for the period ended June 26, 2011, covering the three and six months ended June 26, 2011, compared with June 27, 2010. Papa John’s operated 3,733 restaurants at quarter-end, including 618 company-owned and 3,115 franchised restaurants across all 50 states and 32 countries.
Revenue was generated from company-owned restaurant sales, franchise royalties and fees, food and paper distribution to restaurants, international operations, and related services. Management reclassified Hawaii, Alaska, and Canada from International to North America franchising, with prior periods reclassified accordingly.
Financial performance and key metrics
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Total revenue | $293.5 million | $280.6 million | $606.0 million | $566.4 million |
| Operating income | $19.2 million | $22.8 million | $46.4 million | $50.7 million |
| Net income attributable to Papa John’s | $12.1 million | $13.2 million | $28.6 million | $30.1 million |
| Diluted EPS | $0.47 | $0.49 | $1.11 | $1.11 |
| Operating margin | 6.5% | 8.1% | 7.7% | 9.0% |
| Net margin attributable to Papa John’s | 4.1% | 4.7% | 4.7% | 5.3% |
- Revenue increased 4.6% in the quarter and 7.0% year to date. Domestic company-owned comparable sales increased 2.1% and 4.4%, respectively.
- North America franchise royalty revenue increased 3.8% in the quarter and 6.6% year to date. North America franchised comparable sales decreased 0.1% in the quarter but increased 2.9% year to date.
- International revenue increased 23.6% in the quarter and 21.3% year to date, supported by unit growth and constant-dollar comparable sales increases of 4.8% and 5.2%.
- Domestic company-owned restaurant margin declined to 19.4% in the quarter from 21.2% reported in the prior year, or 20.7% excluding the 2010 BIBP impact. The decline primarily reflected higher commodity and advertising costs.
- Domestic commissary and other margin declined to 6.1% from 8.9% in the quarter and to 7.4% from 9.0% year to date, primarily due to higher commodity and fuel-related distribution costs, lower volumes in the quarter, and lower online ordering fee revenue.
- General and administrative expense declined to $27.6 million from $29.0 million in the quarter, while net interest expense declined to $88,000 from approximately $1.1 million.
- Cash flow from operating activities was $50.1 million for the first six months, compared with $45.7 million in 2010. Management-defined free cash flow was $37.7 million, compared with $22.7 million.
- Capital expenditures were $12.4 million. Share repurchases totaled $26.2 million for 817,000 shares during the first six months.
- Cash and cash equivalents declined to $20.1 million from $46.2 million at December 26, 2010, primarily reflecting debt repayment and share repurchases.
- Long-term debt declined to $48.0 million from $99.0 million. The company had $113.6 million of availability under its $175.0 million unsecured revolving facility, after specified reductions for letters of credit.
Material changes versus the prior comparable period
- Reported profitability decreased because the prior-year results included $2.7 million of pretax income in the quarter and $6.2 million year to date from consolidating BIBP Commodities, Inc., a cheese-purchasing variable interest entity. BIBP ceased operations after the purchasing arrangement was terminated in February 2011.
- Excluding BIBP, management reported pretax income, net of noncontrolling interests, of $18.1 million in the quarter versus $18.1 million in the prior year and $43.8 million year to date versus $40.4 million.
- Lower average debt and the expiration of two interest-rate swaps in January 2011 materially reduced interest expense. The revolving facility carried a variable rate, with an effective rate of 1.19% at quarter-end.
- Domestic company-owned and commissary profitability deteriorated despite revenue growth, while North America franchising and International improved.
- Unallocated corporate expenses declined $3.6 million in the quarter and $4.7 million year to date, primarily due to lower incentive compensation, lower sponsorship costs, lower interest expense, and the absence of certain discretionary franchise-support contributions made in 2010.
- The 2011 National Marketing Fund Agreement increased the marketing contribution rate to 4.0% of sales, reduced online ordering fees charged to domestic franchisees by 0.5%, and introduced royalty rebates and other franchise support incentives.
Outlook, commentary, risks, contingencies, and unusual items
- The filing does not provide a clear formal earnings or revenue guidance range. Management expects increased national marketing investment to improve brand-message consistency and brand awareness, but results remain dependent on sales growth, unit development, and operating profitability.
- Commodity costs, particularly cheese, wheat, and meats, were significant margin pressures. Cheese historically represented approximately 35% to 40% of total food cost. Management’s July 27, 2011 futures-based estimates implied elevated 2011 cheese prices, but these estimates were not guarantees.
- Management identified risks from aggressive competitor pricing and promotions, consumer spending and preferences, labor, fuel, food and other commodity costs, food safety or recalls, international operations, foreign currency and interest rates, franchisee financial condition, and legal or regulatory developments.
- The company remains contingently liable for approximately 50 United Kingdom restaurant leases and one distribution-center lease related to former Perfect Pizza operations. The estimated maximum undiscounted payments were approximately $4.3 million, but the filing states that potential liability could not be reasonably estimated after Perfect Pizza entered administration on August 1, 2011; no amount was recorded as of June 26, 2011.
- Potential impairment risk remains for the United Kingdom subsidiary, which had $22.4 million of net investment and $15.2 million of allocated goodwill at quarter-end. Failure of improvement initiatives could result in future impairment charges.
- The company reported a $4.1 million net deferred tax asset without a valuation allowance and stated that future earnings were expected to support realization.
- Management concluded that disclosure controls and procedures were effective and reported no material changes in internal control over financial reporting.
Important facts for investors to verify
- Whether higher commodity, fuel, advertising, and distribution costs continue to pressure domestic restaurant and commissary margins.
- The sustainability of reported earnings growth excluding the nonrecurring or discontinued BIBP contribution included in 2010.
- Future cheese prices and the financial performance of the replacement cheese purchasing arrangement with PJ Food Service.
- Progress in improving the United Kingdom business and the risk of additional goodwill or long-lived asset impairment.
- The company’s use of cash for share repurchases versus debt reduction and the resulting liquidity position.
- Potential obligations associated with the former Perfect Pizza leases and the outcome of the administration and lease-assumption process.
- Compliance with the revolving credit facility’s leverage and interest-coverage covenants; quarter-end actual ratios were 0.5-to-1.0 leverage versus a 2.5-to-1.0 maximum and 4.9-to-1.0 interest coverage versus a 3.5-to-1.0 minimum.