Panera's "Rapid Pick Up" and mobile ordering is helping drive more traffic. Image source: Panera Bread Co. 

Panera Bread Co. (PNRA) reported second-quarter financial results on July 26, delivering financial and operating performance that exceeded the expectations of many investors. The company also raised its adjusted earnings guidance for the full year, even as other restaurant chains report declining traffic and caution that business could continue to slow. 

So what's happening at Panera Bread that's driving better-than-industry results? Let's take a closer look at the company's second-quarter earnings report.

The numbers

MetricQ2 2016Q2 2015Change
Revenue  $698.9  $676.7 3.3%
Net income  $34.5  $41.9 (17.7%)
Earnings per share  $1.5  $1.60 (8.8%)
Adjusted EPS  $1.78  $1.61 10.6%
Comparable sales 4.2% 2.4% 180 BPS

Data source: Panera Bread. Revenue and net income in millions. BPS = basis points.

A quick explanation of the adjusted earnings per share as compared with Panera's GAAP earnings: Panera has been working toward shifting a number of its company-owned locations to franchisees, with an initial goal of refranchising 50 to 150 company-owned locations. According to the earnings release, Panera had successfully refranchised 102 locations to date, and in the second quarter it reported $7.9 million in losses related to its refranchising efforts. Of this amount. $7.2 million was related to the decision to sell its Canadian operations -- which had been operating at a loss -- to a Canadian-based franchisee.

So by providing both the GAAP and adjusted earnings numbers, we can see both the one-time impact of the sale of those locations, as well as get a better idea how the company's operations would perform going forward.

Keys to the quarter

  •  Panera's company-owned comps growth of 4.2% was strong, but systemwide comps weren't as spectacular. Franchise comps were up only 0.6%, leading to systemwide comps growth of 2.3%. 
    • Company-owned stores continue to report strong results, with comps up 3.1% through the first 27 days of Q3. 
  • Restaurant margin increased 120 basis points from last year, mainly because of lower food costs and higher comp sales. 
  • Operating margin decreased 150 basis points, however, because of refranchising costs. 
    • Adjusted operating margin also increased, but only 50 basis points. Key drivers were higher wages and the impact of start-up costs related to strategic initiatives. 
  • 10 net-new locations were opened in the quarter. Nine company-owned and eight franchised locations were opened, while five company-owned and two franchised locations were closed in the quarter. 
    • Management says Panera will open 90 to 100 new locations this year. 
  • Panera ended the quarter with $160 million in cash.

What management said

Co-founder and CEO Ronald Shaich, on how Panera's growth and profit-boosting initiatives are paying off:

"And we are experiencing this strength in our business even in the face of an industry that's feeling the effects of a weakened business environment and tightening consumer spending. As well, with another quarter of data relative to our initiatives under our belt and with data that is now more robust and mature relative to the performance of these initiatives, we can more confidently project how our business will perform as our start-up and transition costs fall away."

More from Shaich, on the strength of Panera 2.0 on delivering meaningful revenue growth:

"The impact of Panera 2.0 can be clearly seen in the fact that, in Q2, company comps outpaced franchise comps by 360 basis points, which is the largest difference in the history of our company. Investors should note that Panera 2.0 and, to a very small degree a few more delivery cafes, are the only material differences between company and franchise cafes."

Through the end of the second quarter, 522 company-owned stores had been converted to the Panera 2.0 format, while only 48 franchised locations had been converted. The company is touting its utilization of digital ordering and payment as a key driver for its results. Shaich again:

"I'm excited to tell you that we achieved yet another significant milestone in our digital journey just last week, when we hit a digital utilization rate of 20% for the first time. I will add that, in Q2, Panera 2.0 cafes averaged digital utilization rates of 23% and mature Panera 2.0 cafes reached digital utilization rates of almost 30%.

Looking ahead

Panera has started to deliver on its goal of double-digit earnings growth -- at least on an adjusted basis. The next step is to complete its refranchising plans and move beyond theses costs, and to also complete its Panera 2.0 rollout to the rest of its stores. But there's more that the company is counting on to drive more business through each Panera bakery-cafe, including catering, delivery, and more of its Panera at Home products available from retail channels. 

The company calls catering a $1 billion market opportunity, and the run rate on delivery, based on early testing, could make it worth $500 million in annual sales within six months of rolling it out to the entire store base.

Panera at Home is already a $115 million retail business, and the company announced in June that it was going to remove all artificial ingredients from these products by the end of the year. Once this is complete, Panera will have a real chance to compete in the "better for you" packaged-foods category, which has been a bright spot for growth in the consumer packaged-foods business. It's also a massive multibillion-dollar industry. 

Even after reporting comps growth of 3.1% to start the third quarter, management is holding fast on its expectations for 4%-5% comps growth for the full year, largely based on the company's strong outperformance of the restaurant industry's traffic so far this year. And frankly, that outperformance might be more important than what the actual comp number is at year end. 

After all, the comp improvement and industry outperformance is a product of the company's executing on its plan to reignite sales and earnings growth. So far, it looks as if it's working out pretty well.