Papa John’s International, Inc. — Form 10-Q Summary
Business Context and Reporting Period
Quarterly report for the period ended September 27, 2009, comparing the three and nine months ended September 27, 2009 with the comparable periods ended September 28, 2008. Papa John’s operated 3,458 restaurants at quarter-end, including 613 company-owned and 2,845 franchised locations across all 50 states and 29 countries.
Financial Performance and Key Metrics
| Metric | Q3 2009 | Q3 2008 | 9M 2009 | 9M 2008 |
|---|---|---|---|---|
| Total revenues | $263.9 million | $280.0 million | $825.6 million | $852.4 million |
| Operating income | $19.7 million | $13.5 million | $74.6 million | $43.7 million |
| Income before taxes | $18.4 million | $11.8 million | $70.8 million | $38.8 million |
| Net income attributable to Papa John’s | $11.7 million | $7.7 million | $43.8 million | $24.0 million |
| Diluted EPS | $0.42 | $0.28 | $1.57 | $0.84 |
| Operating margin | 7.5% | 4.8% | 9.0% | 5.1% |
| Effective tax rate | 31.3% | 32.3% | 34.0% | 34.4% |
Domestic company-owned restaurant operating margins were 20.7% for the quarter and 22.4% year to date, compared with 16.8% and 18.0% in the prior-year periods. Excluding BIBP, margins were 19.7% and 21.0%, respectively, versus 16.2% and 18.6%.
Cash flow from operating activities was $82.4 million in the first nine months of 2009, compared with $47.6 million in 2008. Excluding BIBP, operating cash flow was $61.4 million versus $59.0 million. Capital expenditures were $21.0 million, and share repurchases were $5.0 million.
Cash and cash equivalents increased to $42.7 million at September 27, 2009, from $11.0 million at December 28, 2008. Total debt declined to $99.9 million from $130.7 million, primarily due to $24.5 million of repayments on the revolving credit facility and lower VIE debt. The $175.0 million unsecured revolving facility had approximately $58.0 million of remaining availability, net of certain letters of credit. The company was in compliance with its debt covenants.
Material Changes Versus the Prior Comparable Period
- Revenue declined 5.7% in the quarter and 3.2% year to date, largely because of lower commodity-driven commissary sales and the sale of 62 lower-performing company-owned restaurants in late 2008.
- Comparable company-owned sales declined 0.6% in the quarter and 0.2% year to date. Comparable franchise sales increased 0.2% in both periods.
- Domestic company-owned restaurant profitability improved because of lower commodity and utility costs and the divestiture of unprofitable restaurants. No comparable 2009 impairment and disposition losses were recorded, versus $3.9 million in the third quarter and $5.1 million year to date in 2008.
- Domestic franchise royalties increased 4.5% in the quarter and 1.1% year to date. The standard royalty rate increased from 4.25% to 4.50% during the final five weeks of the quarter.
- International operating losses narrowed to $0.9 million in the quarter and $2.5 million year to date, compared with losses of $1.2 million and $4.5 million in 2008, although management noted slowing sales and unit growth from global economic conditions.
- General and administrative expense increased to $30.0 million, or 11.4% of revenue, from $26.2 million, or 9.3%, in the quarter. Year-to-date expense increased to $87.8 million from $80.6 million.
- Corporate costs included higher incentive compensation, management transition and severance costs, franchise support initiatives, and a $1.1 million litigation settlement year to date. A third-quarter reduction-in-force eliminated 35 positions and generated approximately $0.9 million of severance costs; management expected annual savings of approximately $2.6 million.
Guidance, Outlook, Risks, and Unusual Items
- BIBP Commodities, a franchisee-owned cheese-purchasing entity consolidated as a variable interest entity, contributed $5.1 million of pretax income in the quarter and $21.0 million year to date, compared with $2.8 million and a $11.4 million loss in the prior-year periods. This materially affected reported earnings and is subject to cheese-price volatility.
- Management expected BIBP to substantially repay its cumulative deficit by the end of 2011. Based on October 28, 2009 futures prices, the company projected BIBP to increase pretax income by approximately $24.1 million for full-year 2009 and by approximately $7.3 million through the third quarter of 2010; management cautioned that actual results have historically differed significantly from such projections.
- Cheese costs represented approximately 35% to 40% of total food costs and remained exposed to seasonal, supply, demand, weather, and commodity-market factors.
- The company expected its revolving-credit balance to remain approximately $99.0 million through the remainder of 2009 and into 2010, using excess cash flow to build cash balances. Planned capital expenditures and potential share repurchases were expected to be funded through operating cash flow and available borrowing capacity.
- Key risks include economic conditions and consumer spending, competition, commodity and labor costs, the ability to pass through cost increases, franchisee financial condition, international operations, legal claims, impairment of goodwill or long-lived assets, insurance reserves, tax audits, and contingent lease obligations.
- The company remained contingently liable for approximately $6.2 million of undiscounted payments under about 70 leases associated with former Perfect Pizza operations; no liability was recorded because cross-default provisions were viewed as substantially reducing the current risk of payment.
- SFAS No. 167, affecting variable-interest-entity assessments, was scheduled for adoption in the first quarter of 2010. The company had not assessed its potential financial statement impact.
- No subsequent events requiring disclosure were identified through November 3, 2009. Management concluded that disclosure controls and procedures were effective, with no material changes to internal control over financial reporting.
Important Facts for Investors to Verify
- Assess reported earnings and projected results excluding the volatile BIBP consolidation impact, including the $21.0 million year-to-date pretax contribution.
- Verify the sustainability of improved company-owned restaurant margins after commodity prices, utility costs, and the 2008 restaurant divestitures normalize.
- Monitor comparable sales, franchisee health, unit openings and closures, and the effect of the higher royalty rate.
- Review liquidity, the $99.0 million revolving-credit balance, approximately $58.0 million of availability, covenant compliance, and the January 2011 facility expiration.
- Evaluate exposure to cheese and other commodity prices, including the sensitivity of BIBP results to market prices.
- Review higher corporate spending, management transition costs, franchise support contributions, litigation, doubtful franchisee notes, international losses, and potential impairment charges.