Papa John’s International, Inc. — 2010 Q2 Form 10-Q Summary
Business context and reporting period
Quarterly report for the period ended June 27, 2010. Papa John’s operated 3,516 restaurants in 50 states and 28 countries, including 619 company-owned and 2,897 franchised locations. Revenue was generated primarily from company-owned restaurants, franchise royalties and fees, commissary sales, and international operations.
Key financial metrics
| Metric | Three months ended June 27, 2010 | Three months ended June 28, 2009 | Six months ended June 27, 2010 | Six months ended June 28, 2009 |
|---|---|---|---|---|
| Revenue | $280.6 million | $268.5 million | $566.4 million | $549.4 million |
| Operating income | $22.8 million | $24.6 million | $50.7 million | $55.0 million |
| Net income attributable to Papa John’s | $13.2 million | $14.2 million | $30.1 million | $32.0 million |
| Diluted EPS | $0.49 | $0.51 | $1.11 | $1.15 |
| Operating margin | 8.1% | 9.2% | 9.0% | 10.0% |
| Net margin attributable to Papa John’s | 4.7% | 5.3% | 5.3% | 5.8% |
| Cash flow from operations | Not separately provided | Not separately provided | $45.7 million | $54.5 million |
| Free cash flow, non-GAAP | Not separately provided | Not separately provided | $22.7 million | $23.5 million |
Cash and cash equivalents were $37.7 million at June 27, 2010, compared with $25.5 million at December 27, 2009. Total debt was $99.0 million, consisting primarily of the revolving credit facility; the full balance was classified as current because the facility expires in January 2011. Approximately $59.7 million of availability remained, and the company was in compliance with its debt covenants.
Capital expenditures were $16.9 million in the first six months. The company repurchased $24.4 million of common stock during the period and had approximately $52.7 million remaining under its repurchase authorization as of July 28, 2010.
Material changes versus the prior comparable period
- Revenue increased 4.5% in the quarter and 3.1% year to date, driven primarily by higher franchise royalties, commissary volumes, and international unit growth.
- Domestic company-owned comparable sales declined 1.1% in the quarter and 1.5% year to date. Increased customer traffic was more than offset by lower average ticket prices from heavier discounting.
- Domestic franchise royalties increased 16.9% in the quarter and 16.2% year to date, primarily because the standard royalty rate increased from 4.25% to 4.75%.
- Domestic company-owned restaurant margin declined to 21.2% from 22.9% in the quarter and to 22.0% from 23.2% year to date. Management cited discounting, occupancy and other operating costs, and reimbursement-related initiatives.
- Domestic commissary margin declined to 8.9% from 10.1% in the quarter and to 9.0% from 10.1% year to date, reflecting lower pricing, higher commodity and fuel costs, and distribution expenses.
- International operating losses widened to $1.1 million in the quarter and $2.2 million year to date, primarily from higher personnel, franchise support, and United Kingdom commissary start-up costs.
- Income attributable to the BIBP cheese-purchasing variable interest entity fell to $2.7 million from $6.9 million in the quarter and to $6.2 million from $15.9 million year to date. Excluding BIBP, management reported that pre-tax income, net of noncontrolling interests, increased by approximately $2.7 million in the quarter and $6.0 million year to date.
- Operating cash flow declined year to date, but excluding BIBP increased to $39.5 million from $38.7 million. Free cash flow decreased modestly to $22.7 million from $23.5 million.
Guidance, outlook, risks, contingencies, and unusual items
- Management expected the revolving credit facility to be renewed or extended during the third quarter of 2010 and anticipated no difficulty doing so.
- A July 2010 workforce reduction and G&A initiative was expected to have no significant impact on second-half 2010 operating income. Estimated annual savings were $4.0 million to $4.5 million in 2011.
- Management expected the effective tax rate to approximate 35% to 36% over time.
- BIBP’s results remain highly sensitive to cheese prices. Based on July 28, 2010 futures prices, the company projected BIBP to increase 2010 pre-tax income by approximately $7.7 million, but stated that actual results can differ significantly. BIBP had a $9.0 million stockholders’ deficit and $18.8 million of short-term debt owed to Papa John’s at June 27, 2010. Papa John’s also guaranteed BIBP’s $10.0 million bank line, which had no outstanding balance.
- The company remained contingently liable for 62 former Perfect Pizza lease arrangements, with approximately $4.8 million of potential undiscounted payments through 2017. No liability was recorded because cross-default provisions were viewed as substantially reducing the payment risk.
- Key risks include aggressive competitor pricing and promotions, commodity, fuel and labor-cost inflation, food safety or recall events, consumer spending and preference changes, international operating losses, franchisee financial weakness, potential impairment of United Kingdom assets, tax uncertainties, and ordinary-course legal claims.
- The company adopted revised variable-interest-entity accounting in 2010. Prior-period revenue was retrospectively reduced by $11.2 million for the quarter and $16.9 million for the six months, with no impact on prior-period operating income or EPS.
Important facts for investors to verify
- Confirm renewal or refinancing of the $99.0 million revolving credit facility before its January 2011 expiration.
- Monitor comparable sales, discounting, average ticket trends, and domestic company-owned restaurant margins.
- Assess the sensitivity of earnings and cash flow to cheese prices and the continuing BIBP consolidation.
- Evaluate whether the international expansion and United Kingdom commissary investments can reduce international operating losses without triggering further impairment charges.
- Reconcile reported GAAP results with management’s non-GAAP results excluding BIBP and review the effects of the VIE accounting change.
- Track execution of the G&A reduction initiative and whether the projected $4.0 million to $4.5 million of 2011 savings are realized.
- Review the pace and funding of share repurchases relative to cash flow, capital expenditures, liquidity, and debt maturities.