Papa John’s International, Inc. — Q3 2010 Form 10-Q Summary
Business context and reporting period
The filing covers the quarter and nine months ended September 26, 2010, compared with September 27, 2009. Papa John’s operated 3,583 restaurants in all 50 states and 29 countries, including 610 company-owned and 2,973 franchised restaurants. Revenue is generated from company-owned restaurant sales, franchise royalties and fees, commissary distribution, international operations, and related services.
Key financial metrics
| Metric | Q3 2010 | Q3 2009 | 9M 2010 | 9M 2009 |
|---|---|---|---|---|
| Total revenue | $273.1 million | $256.3 million | $839.6 million | $805.8 million |
| Operating income | $13.8 million | $19.6 million | $64.5 million | $74.6 million |
| Income before tax | $12.5 million | $18.4 million | $61.1 million | $70.8 million |
| Net income attributable to Papa John’s | $7.8 million | $11.7 million | $37.9 million | $43.8 million |
| Diluted EPS | $0.30 | $0.42 | $1.42 | $1.57 |
| Operating margin | 5.0% | 7.7% | 7.7% | 9.3% |
Net cash provided by operating activities was $62.2 million for the first nine months, down from $82.3 million in the prior-year period. Management-defined free cash flow, excluding BIBP’s pre-tax results and capital expenditures, was $33.0 million versus $40.3 million.
At September 26, 2010, cash and cash equivalents were $28.2 million, total assets were $397.9 million, and total stockholders’ equity was $193.3 million. Debt was $99.0 million, consisting principally of borrowings under a $175.0 million unsecured revolving facility. Remaining availability, net of letters of credit, was approximately $59.7 million. The company was in compliance with all debt covenants.
Material changes versus the prior comparable period
- Revenue increased 6.5% in the quarter and 4.2% year to date, primarily from higher franchise royalties, increased commissary sales, and international unit growth.
- Domestic company-owned restaurant sales declined 1.3% in the quarter and 1.1% year to date; comparable sales declined 1.6% and 1.5%, respectively. Increased discounting reduced average ticket values.
- Domestic franchise royalties increased 8.8% in the quarter and 13.7% year to date, supported by standard royalty-rate increases from 4.25% to 4.50% in September 2009 and to 4.75% in the first quarter of 2010.
- Domestic company-owned restaurant operating margin declined to 18.2% in the quarter and 20.8% year to date, from 20.7% and 22.4%, respectively. Excluding BIBP, margins were 18.3% and 20.4%, versus 19.7% and 21.0%.
- Domestic commissary margin declined to 7.3% in the quarter and 8.4% year to date, from 8.9% and 9.8%, due to lower pricing margins, commodity costs, distribution expenses, and fuel costs.
- Domestic franchising income increased $1.2 million in the quarter and $6.1 million year to date. International losses widened to $1.0 million and $3.2 million, respectively, reflecting higher personnel and franchise support costs and United Kingdom commissary start-up costs.
- The BIBP cheese-purchasing variable interest entity produced a $0.7 million pre-tax loss in the quarter and $5.5 million of pre-tax income year to date, compared with $5.1 million and $21.0 million of pre-tax income in the prior-year periods. BIBP therefore reduced quarterly results but increased year-to-date results.
- Shares repurchased during the first nine months totaled approximately 1.7 million for $43.2 million. The weighted average diluted share count declined to 26.1 million in the quarter and 26.7 million year to date.
Guidance, outlook, commentary, risks, and unusual items
- No formal revenue or EPS guidance is provided in the filing. Management expects the July 2010 reduction-in-force and cost-reduction initiative to generate approximately $4.0 million of annual savings in 2011, with no significant 2010 operating-income benefit after severance and related costs.
- Management expects to fund remaining 2010 capital expenditures and additional share repurchases from cash on hand and operating cash flow. Approximately $39.4 million remained available under the repurchase authorization as of October 27, 2010.
- The new five-year revolving credit facility executed in September 2010 carries variable-rate pricing of 100 to 175 basis points over LIBOR, subject to leverage. Interest-rate swaps fixed rates on $100 million of borrowings at 4.98% and 3.74% through January 2011.
- BIBP results are highly sensitive to cheese prices and can materially affect reported operating income. Based on October 27, 2010 futures prices, management projected a $6.2 million pre-tax BIBP benefit for 2010 and a $7.5 million benefit for 2011, but stated that actual results may differ substantially.
- BIBP had a cumulative pre-tax deficit of approximately $14.6 million at September 26, 2010. Management expected, but did not assure, substantial repayment by the end of 2012.
- The company had a contingent obligation of approximately $4.8 million for 62 leases related to the 2006 sale of former Perfect Pizza operations in the United Kingdom. No liability was recorded because cross-default provisions were viewed as reducing the payment risk.
- Other key risks include aggressive competitor pricing and promotions, commodity, labor, fuel and insurance costs, consumer demand, franchisee financial condition, international operations, food safety, legal claims, tax matters, and potential impairment of United Kingdom goodwill and other long-lived assets.
- Adoption of revised variable-interest-entity accounting removed certain franchise entities from consolidation and retrospectively excluded $10.4 million of 2009 third-quarter revenue and $27.3 million of 2009 nine-month revenue, without affecting prior-period operating income or EPS.
- Management concluded that disclosure controls and procedures were effective and reported no material changes in internal control over financial reporting.
Most important facts for investors to verify
- Whether comparable-store sales and company-owned restaurant margins recover from the 2010 declines caused by discounting and commodity pressure.
- The realized impact of BIBP and cheese prices versus the filing’s futures-based projections.
- Execution of the announced $4.0 million annual cost savings and the effect of international expansion and the United Kingdom operations.
- Liquidity after capital expenditures, share repurchases, franchisee lending, and any additional BIBP funding requirements.
- Compliance with revolving-credit covenants and refinancing or interest-rate exposure when the swaps expire in January 2011.
- Potential exposure from franchisee notes receivable, including $7.4 million of reserves against approximately $17.4 million of net notes receivable.
- Developments involving the $4.8 million Perfect Pizza lease contingency, legal claims, tax reserves, and possible impairment of United Kingdom assets.