Business Context and Reporting Period
Papa John’s International, Inc. filed a Form 10-Q for the three months ended March 28, 2010, compared with March 29, 2009. The company operated 3,491 restaurants at quarter-end, including 618 company-owned and 2,873 franchised locations in all 50 states and 29 countries.
Financial Performance and Position
| Metric | Q1 2010 | Q1 2009 | Change |
|---|---|---|---|
| Total revenues | $285.8 million | $280.9 million | Up 1.7% |
| Operating income | $27.9 million | $30.4 million | Down $2.4 million |
| Net income attributable to Papa John’s | $16.9 million | $17.8 million | Down 5.4% |
| Diluted EPS | $0.62 | $0.64 | Down $0.02 |
| Cash flow from operations | $26.0 million | $31.9 million | Down $5.9 million |
| Free cash flow | $13.4 million | $17.8 million | Down $4.4 million |
- Domestic company-owned restaurant sales declined 1.6%, reflecting a 1.8% decrease in comparable sales. Increased traffic was more than offset by lower average ticket size from greater discounting.
- Franchise royalties increased to $17.7 million from $15.4 million, primarily because the standard domestic royalty rate increased from 4.25% to 4.75%.
- Domestic commissary sales increased 2.8% to $112.6 million, but commissary operating income declined to $7.1 million from $9.4 million. The commissary margin fell to 9.0% from 10.2% due to commodity, pricing, delivery and fuel pressures.
- Excluding the BIBP variable-interest entity, pretax income attributable to the company increased to approximately $22.4 million from approximately $19.2 million, according to management’s non-GAAP presentation.
- Domestic company-owned restaurant operating margin was 22.8%, compared with 23.4%. Excluding BIBP, the margin improved to 22.1% from 21.7%.
- Cash and cash equivalents were $42.6 million at March 28, 2010, compared with $25.5 million at December 27, 2009.
- Total debt was $99.0 million, consisting principally of borrowings under a $175.0 million unsecured revolving credit facility. Approximately $58.0 million remained available, subject to letters of credit and covenants.
- The full debt balance was classified as current because the facility expires in January 2011. Management stated that it planned to renew and extend the facility and did not anticipate renewal problems.
- The company repurchased approximately 215,000 shares for $5.3 million during the quarter and repurchased an additional 92,000 shares for $2.4 million through April 27, 2010.
Material Changes Versus the Prior Comparable Period
- Reported operating income and earnings declined despite modest revenue growth, primarily because the favorable contribution from BIBP declined materially.
- BIBP generated $3.5 million of pretax income in Q1 2010, compared with $9.0 million in Q1 2009, reducing reported pretax income by approximately $5.5 million year over year.
- Excluding BIBP, company-owned restaurant profitability, domestic franchising results and corporate expenses improved, while commissary and international results weakened.
- The international operating loss increased to $1.1 million from $0.8 million, partly because of personnel, franchise support and start-up costs for a United Kingdom commissary expected to open in Q2 2010.
- The company adopted amended variable-interest-entity consolidation guidance. Certain franchise entities were no longer consolidated, reducing previously reported December 2009 assets by $3.4 million and reducing Q1 2009 reported revenue by $5.7 million, without affecting prior-period operating income or EPS.
- Shares outstanding declined, with basic weighted-average shares falling to 27.0 million from 27.6 million, although management stated that first-quarter repurchases had no impact on EPS.
Guidance, Outlook, Risks and Unusual Items
- Management expected the effective tax rate to approximate 35% to 36% over time; quarterly rates may fluctuate because of tax settlements and other jurisdictional matters.
- Based on April 27, 2010 cheese futures prices, management projected BIBP to increase 2010 pretax income by approximately $9.1 million, including $2.5 million in Q2, $1.5 million in Q3 and $1.6 million in Q4. Actual results may differ significantly because of cheese-price volatility.
- BIBP had a $10.0 million commercial line of credit guaranteed by Papa John’s and $22.3 million of short-term debt from Papa John’s at quarter-end. BIBP had a $10.7 million accumulated shareholders’ deficit.
- Cheese costs historically represented approximately 35% to 40% of total food costs and remain exposed to weather, availability, demand and commodity-market conditions.
- Other principal risks include competitive pricing and promotions, consumer spending, food, fuel and labor costs, franchisee performance, international operations, legal claims, health-care legislation and the potential need to recognize impairment charges related to the United Kingdom business or certain domestic markets.
- The company remained contingently liable for 62 lease arrangements associated with the former Perfect Pizza operations. Potential undiscounted payments were approximately $5.2 million, but no liability was recorded because management believed cross-default provisions significantly reduced the risk of payment.
- Management reported that disclosure controls were effective and that there were no material changes in internal control over financial reporting during the quarter.
Investor Verification Priorities
- Verify the renewal or refinancing of the $99.0 million revolving credit facility before its January 2011 expiration.
- Track BIBP’s cheese-price exposure, debt, deficit position and its effect on reported earnings versus results excluding BIBP.
- Assess whether discounting, lower average ticket size and the 1.8% comparable-sales decline persist.
- Monitor commissary margins, commodity and fuel costs, and the profitability of the planned United Kingdom commissary.
- Reconcile GAAP results with management’s non-GAAP measures excluding BIBP and evaluate whether those measures remain useful for period-to-period comparisons.
- Review franchisee credit quality, the $7.5 million reserve for potentially uncollectible notes receivable, the $13.0 million net deferred tax asset and the $5.2 million lease contingency.