Papa John’s International, Inc. — FY2010 Form 10-K Summary
Business context and reporting period
Papa John’s operates and franchises pizza delivery and carryout restaurants, with selected dine-in and restaurant-based delivery operations internationally. The filing covers the 52-week fiscal year ended December 26, 2010, with comparisons to the 52-week years ended December 27, 2009 and December 28, 2008. At year-end, the system had 3,646 restaurants: 612 company-owned and 3,034 franchised, operating domestically and in 32 countries.
- Reportable segments included domestic company-owned restaurants, domestic commissaries, domestic franchising, international operations, variable interest entities and all other businesses.
- The company opened 325 restaurants and closed 148 during 2010, producing net unit growth of 177 restaurants.
- Domestic online ordering exceeded 28% of total domestic sales after the redesigned digital platform launched in the fourth quarter.
Financial performance and key metrics
| Metric | 2010 | 2009 | Change |
|---|---|---|---|
| Total revenue | $1,126.4 million | $1,078.6 million | +4.4% |
| Operating income | $86.7 million | $95.2 million | -8.9% |
| Operating margin | 7.7% | 8.8% | -110 bps |
| Income before taxes | $82.3 million | $90.2 million | -8.8% |
| Net income attributable to shareholders | $51.9 million | $57.5 million | -9.6% |
| Diluted EPS | $1.96 | $2.06 | -4.9% |
| Cash flow from operations | $89.1 million | $100.1 million | -11.0% |
| Free cash flow, excluding BIBP impact | $51.2 million | $44.0 million | +16.3% |
- Revenue growth was led by an 8.8% increase in domestic commissary sales, a 12.0% increase in domestic franchise royalties and 15.7% growth in international revenues. Company-owned restaurant sales declined 0.1%.
- Domestic company-owned comparable sales decreased 0.6%, while domestic franchised comparable sales increased 0.3%.
- Domestic company-owned restaurant operating margin declined to 20.2% from 21.8%; excluding BIBP, the margin was 19.9% versus 20.7%. Management attributed the decline primarily to increased discounting and lower average ticket prices.
- Domestic commissary and other margin declined to 8.6% from 9.8%, reflecting commodity and fuel-cost pressures, lower gross margins and franchise incentive programs.
- Domestic franchising income before taxes increased to $60.9 million from $53.7 million, primarily because of higher royalty rates.
- International operations remained loss-making, with a $3.5 million loss compared with a $3.1 million loss in 2009.
- Cash and cash equivalents totaled $46.2 million at year-end, compared with $25.5 million at December 27, 2009. Total assets were $415.9 million and total stockholders’ equity was $207.2 million.
- Total debt was $99.0 million, substantially all under a $175.0 million unsecured revolving credit facility. Remaining availability, after letters of credit, was approximately $59.1 million.
- The company was in compliance with its debt covenants. Actual leverage was 1.0 times versus a maximum of 2.5 times, and interest coverage was 4.5 times versus a minimum of 3.5 times.
- Capital expenditures were $31.1 million. The company repurchased 1.881 million shares for $46.9 million during 2010; approximately $36.9 million remained available under the authorization at year-end.
Material changes versus the prior comparable period
- Reported operating income and net income declined despite revenue growth, primarily because of lower restaurant margins, higher commodity and distribution costs, international start-up costs and reduced benefit from the cheese-purchasing program.
- BIBP Commodities, a consolidated variable interest entity, contributed approximately $21.0 million of pretax income in 2010 versus $22.5 million in 2009. The 2010 amount included a $14.2 million accounting transfer related to BIBP’s accumulated cheese deficit; it had no impact on consolidated income because both entities were consolidated.
- Excluding the BIBP consolidation, pretax income attributable to the company increased to approximately $72.0 million from $63.9 million, and the related pretax margin increased to 6.4% from 5.9%.
- Franchise support initiatives declined to $6.5 million from $9.6 million, while the company continued to provide royalty relief, marketing support, development incentives and selected franchisee financing.
- The standard domestic royalty rate increased to 4.75% in the first quarter of 2010; the standard rate for 2011 was 5.0%, subject to rebate opportunities.
- The company entered into a new five-year $175.0 million revolving credit facility in September 2010, replacing the prior facility. The new facility carried higher potential spreads over LIBOR.
- The company retrospectively applied revised variable-interest-entity accounting, excluding certain franchise entities from consolidation. Prior-period revenue was reduced by $37.7 million for 2009 and $8.3 million for 2008, without affecting prior-period earnings per share.
Guidance, outlook, commentary, risks and unusual items
- Management expected 2011 net unit growth of approximately 190 to 220 restaurants, including 13 to 15 company-owned openings and 297 to 325 franchised openings, offset by approximately 120 closures.
- 2011 capital expenditures were expected to approximate $35 million to $40 million, including $6 million to $8 million for company-owned restaurant re-imaging.
- The 2011 national marketing fund contribution rate was set at 4.0% of sales. Management expected lower overall franchise support spending than in 2010, although support programs would continue.
- Beginning in 2011, Hawaii, Alaska and Canada were to be reclassified from international operations to North America franchising. The reclassification would shift approximately $1.3 million of 2010 and 2009 operating income to domestic franchising.
- Substantially all domestic franchisees had entered into cheese purchasing agreements by February 15, 2011. Management expected the BIBP structure, or a similar program, to have no significant effect on consolidated income beginning in 2011.
- The online ordering platform generated losses because fees collected from franchisees did not cover development and infrastructure costs. A fee reduction in 2011 and fee caps for 2012 and 2013 were expected to create additional losses, although the company retained the right to seek recovery over time.
- Key risks included aggressive industry pricing, commodity and fuel-cost volatility, dependence on suppliers for cheese, flour and thin-crust dough, franchisee financing constraints, labor and health-care cost increases, food-safety and reputational risks, technology disruptions, international execution and currency risks, litigation, and potential impairment of company-owned or international operations.
- Contractual obligations totaled approximately $222.6 million, including $99.0 million of debt and $123.6 million of operating leases. The company also had $18.2 million of standby letters of credit and a contingent exposure of approximately $4.3 million related to former Perfect Pizza lease arrangements.
- Ernst & Young issued unqualified opinions on the financial statements and internal control over financial reporting. Management concluded that internal controls and disclosure controls were effective.
Most important facts for investors to verify
- Whether revenue growth can continue without further erosion of company-owned restaurant margins from discounting and promotional activity.
- The recurring earnings and cash-flow contribution after the BIBP cheese-purchasing arrangement no longer materially affects results.
- Commodity exposure, particularly cheese, and the company’s ability to pass food, fuel and labor-cost increases through the system.
- Execution of the 190-to-220-unit 2011 growth plan, franchisee financial health and expected closure levels.
- Profitability trajectory for international operations, including the United Kingdom commissary and China expansion.
- Economics of the redesigned online ordering platform after reduced franchisee fees and future fee caps.
- Liquidity after planned capital expenditures, restaurant re-imaging, share repurchases and lease obligations.
- Potential recoverability of franchisee loans, goodwill and other long-lived assets, including the approximately $20.4 million net investment in PJUK.