Papa John’s International, Inc. — Q1 2009 Form 10-Q Summary
Business context and reporting period
Unaudited results cover the three months ended March 29, 2009, compared with the three months ended March 30, 2008. Papa John’s operated 3,404 restaurants at quarter-end: 612 company-owned and 2,792 franchised, across the United States and 29 countries. Revenue is generated from company-owned restaurants, franchise royalties and fees, commissary sales, international operations, and related services.
Financial performance and liquidity
| Metric | Q1 2009 | Q1 2008 |
|---|---|---|
| Total revenue | $285.0 million | $289.0 million |
| Operating income | $30.4 million | $15.8 million |
| Income before taxes | $29.1 million | $14.1 million |
| Net income attributable to Papa John’s | $17.8 million | $8.6 million |
| Diluted EPS | $0.64 | $0.30 |
| Operating margin | Approximately 10.6% | Approximately 5.5% |
| Net margin attributable to Papa John’s | Approximately 6.3% | Approximately 3.0% |
| Cash flow from operations | $32.0 million | $20.3 million |
Cash and cash equivalents were $18.1 million at March 29, 2009, compared with $11.0 million at December 28, 2008. Total debt was $111.5 million, including $103.0 million outstanding on a $175.0 million revolving credit facility and $8.5 million of debt associated with consolidated variable interest entities. Remaining revolver availability, net of certain letters of credit, was approximately $51.6 million. The company was in compliance with its debt covenants.
Investing activities used $8.4 million, primarily for $5.1 million of capital expenditures and $4.0 million of loans issued. Financing activities used $17.4 million, including $20.5 million of revolver repayments, $5.0 million of share repurchases, and $6.1 million of proceeds from stock-option exercises.
Material changes versus the prior comparable period
- Total revenue declined 1.4%, primarily because 62 company-owned restaurants were divested to franchisees in late 2008. Comparable company-owned sales increased 0.3%.
- Operating income increased $14.6 million. The principal driver was a $9.0 million pre-tax gain from the consolidated cheese-purchasing entity, BIBP, compared with an $8.0 million pre-tax loss in Q1 2008.
- Excluding BIBP, income before taxes and noncontrolling interests declined to approximately $19.1 million from $21.5 million, according to management.
- Company-owned restaurant operating margin increased to 23.4% from 18.9%; excluding BIBP, the margin increased to 21.7% from 20.2%. Improvements reflected pricing and product mix, labor management, lower discretionary advertising, and the divestiture of higher-cost restaurants.
- Domestic commissary operating income increased approximately $1.0 million, aided by lower fuel-related distribution costs.
- Domestic franchising operating income declined approximately $0.8 million because of fewer domestic openings, lower opening fees, and the absence of certain prior-year renewal fees. The company announced a 25th Anniversary development incentive program offering qualifying franchisees no franchise fee and no royalty for 12 months.
- International operating loss improved to approximately $0.8 million from $1.7 million, while the “All others” segment declined approximately $2.1 million, primarily because of lower profitability in online ordering and print and promotions.
- Unallocated corporate expenses increased $3.8 million, reflecting higher professional fees, management transition costs, franchise support initiatives, and provisions for uncollectible receivables.
- Shares outstanding declined as the company repurchased approximately 275,000 shares for $5.0 million at an average price of $18.05 per share. Approximately $57.3 million remained available under the repurchase authorization at April 29, 2009.
Guidance, outlook, commentary, risks, and unusual items
Management did not provide a clear consolidated revenue or earnings forecast in the filing. Based on April 29, 2009 cheese futures prices, management projected that BIBP consolidation would increase pre-tax income by approximately $20.5 million for full-year 2009, including projected benefits of $6.2 million in the second quarter, $3.1 million in the third quarter, and $2.2 million in the fourth quarter. Management cautioned that historical actual results have differed significantly from futures-based projections.
BIBP is a franchisee-owned variable interest entity consolidated because Papa John’s is deemed its primary beneficiary. BIBP had a $20.7 million accumulated shareholders’ deficit, $8.5 million of third-party borrowings, a $3.0 million letter of credit, and $28.0 million of borrowings from Papa John’s at quarter-end. The cheese-pricing formula was modified in March 2009, and management expected BIBP to substantially repay its cumulative deficit by the end of 2011. Cheese-market volatility may continue to cause significant swings in operating income.
Other key risks include economic weakness and changes in consumer spending, commodity and labor-cost inflation, the ability to pass costs to customers or franchisees, franchisee financial difficulties and collectibility of receivables, competition, international execution, potential impairment of goodwill or long-lived assets, legal claims, and insurance reserve estimates. The filing also identifies dependence on John H. Schnatter, who became CEO and remained Chairman and brand spokesman without an employment agreement or key-person life insurance.
Subsequent to quarter-end, the company agreed to sell ten Albuquerque restaurants for total consideration of approximately $1.1 million and expected to recognize a gain of approximately $0.3 million in Q2 2009. The company adopted SFAS Nos. 141R, 160, and 161 in Q1 2009; SFAS 160 changed the presentation of noncontrolling interests and prior periods were retrospectively modified, while the adoptions otherwise had no material impact on reported results.
Important facts for investors to verify
- Separate recurring operating performance from the unusually favorable $9.0 million BIBP gain and evaluate the sensitivity of future results to cheese prices.
- Reconcile reported results with management’s non-GAAP results excluding BIBP; the filing indicates that pre-tax income excluding BIBP declined year over year.
- Monitor the $103.0 million revolving debt balance, $51.6 million of remaining availability, variable interest exposure, swap liabilities, and compliance with financial covenants.
- Assess franchisee credit quality, including $8.1 million of net loans to consolidated franchise entities and the company’s funding and guarantee obligations to BIBP.
- Evaluate whether improved company-owned restaurant margins and comparable sales offset weaker franchise fees, online-ordering profitability, and corporate expenses.
- Review the impact of the new franchise development incentives on unit growth, royalty revenue, and near-term franchising margins.
- Track potential impairment, insurance, tax, legal, and receivable-collectibility charges, as well as the execution of the United Kingdom improvement plans.