Papa John’s International, Inc. — Form 10-Q Summary
Business context and reporting period
Quarterly report for the three months ended March 27, 2011, compared with the three months ended March 28, 2010. Papa John’s operated 3,687 restaurants at quarter-end, including 613 company-owned and 3,074 franchised units across all 50 states and 32 countries. The company reports domestic company-owned restaurants, domestic commissaries, North America franchising, international operations, variable interest entities and other activities.
Financial performance and liquidity
| Metric | Q1 2011 | Q1 2010 | Change |
|---|---|---|---|
| Total revenues | $312.5 million | $285.8 million | Up 9.3% |
| Operating income | $27.2 million | $27.9 million | Down 2.6% |
| Income before tax, net of noncontrolling interests | $25.7 million | $25.8 million | Down $0.2 million |
| Net income attributable to Papa John’s | $16.4 million | $16.9 million | Down 2.7% |
| Diluted EPS | $0.64 | $0.62 | Up $0.02 |
| Cash flow from operations | $25.6 million | $26.0 million | Down $0.4 million |
| Free cash flow | $20.7 million | $13.4 million | Up $7.3 million |
Revenue growth was led by domestic company-owned restaurant sales of $138.7 million, up 7.0%; domestic commissary sales of $127.7 million, up 13.3%; North America franchise royalties and fees of $19.9 million, up 9.1%; and international revenue of $12.8 million, up 18.8%. Comparable sales increased 6.7% for company-owned domestic restaurants, 5.9% for North America franchised restaurants and 5.6% for international operations on a constant-dollar basis.
Operating margin was approximately 8.7% of revenue, compared with 9.8% in the prior-year quarter. Net margin attributable to Papa John’s was approximately 5.3%, compared with 5.9%. The domestic company-owned restaurant margin declined to 20.4% from 22.8%, or 22.1% excluding the prior-year BIBP benefit, primarily because of higher commodity and advertising costs.
Cash and cash equivalents were $13.7 million at March 27, 2011, compared with $46.2 million at December 26, 2010. Long-term debt declined to $48.0 million from $99.0 million, primarily through a $51.0 million repayment on the revolving credit facility. The $175.0 million unsecured facility had approximately $113.6 million of remaining availability, net of certain letters of credit. The company was in compliance with its debt covenants; the actual leverage ratio was 0.5 to 1.0 versus a maximum permitted 2.5 to 1.0, and the interest coverage ratio was 4.7 to 1.0 versus a minimum required 3.5 to 1.0.
Material changes versus the prior comparable period
- Revenue increased 9.3%, but operating income and GAAP net income declined modestly.
- Domestic company-owned restaurant profit declined approximately $0.6 million because higher commodity and advertising costs offset benefits from increased sales.
- Domestic commissary profit increased approximately $2.4 million, supported by higher sales volumes, partly offset by higher distribution and fuel costs.
- North America franchising profit increased approximately $1.7 million to $18.0 million.
- International operating loss improved to approximately $0.8 million from $1.5 million, partly because the prior year included United Kingdom commissary start-up costs.
- The “All others” segment moved to a loss of approximately $0.4 million from income of $0.9 million, primarily because of weaker Preferred Marketing Solutions results and lower online ordering fees coupled with higher e-commerce support costs.
- BIBP Commodities, the consolidated variable-interest entity supporting the cheese-purchasing program, operated at breakeven in Q1 2011 versus $3.5 million of pre-tax income in Q1 2010, including approximately $0.08 of prior-year diluted EPS.
- The company terminated the BIBP purchasing arrangement in February 2011. More than 99% of domestic franchisees entered into a replacement cheese-purchasing agreement with PJ Food Service.
- The company repurchased approximately 143,000 shares for $4.1 million during the quarter. Approximately $32.7 million remained available under the repurchase authorization.
Guidance, outlook, commentary, risks and unusual items
Management stated that planned 2011 capital expenditures and additional share repurchases are expected to be funded from cash on hand and operating cash flows. The filing does not provide specific full-year revenue or earnings guidance.
Management expects the 2011 national marketing fund agreement to result primarily in a shift or slight increase in total marketing spending and believes increased national marketing may improve brand awareness. The agreement includes a 4.0% 2011 marketing contribution rate, potential royalty rebates, a 0.5% reduction in online ordering fees for domestic franchisees and other franchise support initiatives.
Key risks include aggressive competitor pricing and promotions, consumer demand and economic conditions, food and commodity costs, fuel and labor costs, the ability to pass cost increases to franchisees or customers, food safety and recall exposure, legal and regulatory matters, foreign currency and interest-rate movements, and execution of international growth plans. Cheese costs historically represented approximately 35% to 40% of total food costs; management reported an estimated 2011 average block cheese price of $1.741 per pound based on futures prices, versus an actual 2010 average of $1.503.
The United Kingdom subsidiary had approximately $21.5 million of net investment and $15.2 million of allocated goodwill at quarter-end. Management noted that unsuccessful improvement and growth initiatives could result in future impairment charges. The company also relies on estimates for doubtful accounts, long-lived assets, insurance reserves and deferred taxes.
After quarter-end, President and Co-Chief Executive Officer Jude Thompson resigned effective April 30, 2011 under a separation agreement. The company stated that the agreement was not expected to have a material impact on 2011 earnings. Founder, Chairman and Chief Executive Officer John H. Schnatter continued in his roles.
Important facts for investors to verify
- Assess whether revenue growth can continue while commodity, labor, fuel and advertising costs pressure company-owned restaurant margins.
- Monitor the financial effects and accounting treatment of the replacement cheese-purchasing arrangement following the termination of BIBP.
- Verify the sustainability of cash generation after the substantial debt repayment, capital expenditures and share repurchases.
- Review variable-rate debt exposure: a 100-basis-point increase in rates on the March 27, 2011 revolver balance would increase annual interest expense by approximately $0.5 million.
- Evaluate international profitability and the potential for additional impairment charges related to the United Kingdom operations.
- Consider the effect of royalty rebates, lower online ordering fees and other franchise support initiatives on future franchising margins.
- Review outstanding legal, tax, insurance and franchisee-related contingencies; the filing states that currently pending claims are not expected to have a material adverse effect.