Papa John’s International, Inc. — Form 10-Q Summary
Reporting period: Three and six months ended June 25, 2023, compared with June 26, 2022. The company operated 5,780 restaurants in 48 countries and territories, including 612 company-owned and 5,168 franchised locations.
Business Context and Key Developments
- Revenue is generated from company-owned restaurant sales, franchise royalties and fees, commissary sales, international operations, marketing funds, technology and other services.
- The company opened 47 net new restaurants in the second quarter, representing 0.8% global unit growth.
- On June 2, 2023, the company acquired 91 previously franchised UK restaurants for approximately $13.7 million, establishing a company-owned UK portfolio. Acquisition-related and UK repositioning costs were $1.3 million in the quarter.
- Management reported the sixteenth consecutive quarter of global system-wide restaurant sales growth and continued the “Back to BETTER” operating initiative.
Financial Performance
| Metric | Q2 2023 | Q2 2022 | Six Months 2023 | Six Months 2022 |
|---|
| Total revenue | $514.5 million | $522.7 million | $1.042 billion | $1.065 billion |
| Operating income | $34.9 million | $38.9 million | $72.7 million | $53.3 million |
| Operating margin | 6.8% | 7.4% | 7.0% | 5.0% |
| Net income attributable to the company | $17.8 million | $25.4 million | $40.1 million | $35.9 million |
| Diluted EPS | $0.54 | $0.70 | $1.20 | $0.99 |
| Net interest expense | $11.3 million | $6.1 million | $20.3 million | $10.3 million |
- Second-quarter revenue declined 1.6%; six-month revenue declined 2.2%. Excluding the 2023 UK acquisition and 2022 refranchising, revenue declined 1.9% in the quarter and 0.7% year to date.
- Six-month operating income benefited from the absence of $11.2 million of prior-year refranchising and impairment losses. Reported six-month operating margin improved by 200 basis points, although adjusted operating income declined to $76.0 million from $85.6 million.
- Q2 diluted EPS declined primarily because of lower operating income and higher interest expense. Six-month EPS increased partly because of prior-year one-time charges and a lower share count.
- Effective tax rates were 24.4% in Q2 and 22.9% year to date, compared with 21.6% and 13.6%, respectively, in the prior-year periods.
Sales Trends and Segment Performance
- Domestic company-owned comparable sales increased 2.2% in Q2 and 2.8% year to date. Domestic company-owned operating income increased $0.7 million in Q2 but declined $3.0 million on an adjusted basis year to date.
- North America franchised comparable sales declined 2.3% in Q2 and 1.6% year to date, pressuring royalty performance.
- North America commissary revenue declined 5.7% in Q2 and 2.2% year to date, primarily due to lower volumes and lower commodity pricing.
- International comparable sales declined 0.7% in Q2 and 3.3% year to date, primarily reflecting UK inflationary pressure. International operating income declined $2.2 million in Q2 and $3.0 million year to date on an adjusted basis.
- Total global system-wide restaurant sales increased 2.0% in both Q2 and the first six months, excluding foreign-currency effects.
Cash Flow, Liquidity and Debt
| Metric | Six Months 2023 | Six Months 2022 |
|---|
| Cash flow from operating activities | $93.7 million | $45.6 million |
| Capital expenditures | $34.8 million | $30.7 million |
| Free cash flow | $59.0 million | $14.8 million |
| Cash used in investing activities | $35.7 million | $12.5 million |
| Cash used in financing activities | $61.6 million | $50.7 million |
| Cash and cash equivalents at June 25 | $43.8 million | $52.1 million |
- Total debt was $791.5 million at June 25, 2023, consisting of $400.0 million of 3.875% senior notes and $391.5 million under revolving facilities, compared with $605.0 million at year-end 2022.
- The PJI revolving facility had approximately $224.0 million of remaining availability and matures in September 2026. The PJMF facility had $15.5 million outstanding and matures September 30, 2023, subject to annual amendments.
- The company was in compliance with debt covenants. Actual leverage was 3.4x versus a maximum of 5.25x, and interest coverage was 3.5x versus a minimum of 2.0x.
- Six-month financing outflows included $210.3 million of share repurchases and $28.5 million of dividends, partly funded by $186.5 million of net revolving-facility borrowings.
- The company repurchased 2.523 million shares for an aggregate purchase price of $209.6 million, including 2.177 million shares acquired from funds affiliated with Starboard Value for $179.6 million. Approximately $90.2 million remained available under the repurchase authorization.
Guidance, Outlook and Management Commentary
- Management expects 270 to 310 net new global restaurants in 2023 and annual net unit growth of 5% to 7%. The 2022-to-2025 net unit growth expectation was reduced to 1,150 to 1,400 units from 1,400 to 1,800 because of global economic pressures.
- 2023 capital expenditures are estimated at approximately $80 million to $90 million.
- Management expects cash, operating cash flow and borrowing capacity to fund requirements, dividends, interest payments and planned share repurchases over the next twelve months and beyond.
- The company expects the UK company-owned portfolio to support revenue management, product and technology innovation, operational efficiencies and longer-term profitability, but UK inflation and higher interest rates remain significant challenges.
- The board approved a 9.5% increase in the annualized dividend rate to $1.84 per share and declared a third-quarter dividend of $0.46 per share, payable August 25, 2023.
- Based on July 28, 2023 futures prices, management projected a 2023 full-year average cheese block price of $1.825 per pound, below the 2022 average of $2.067.
Risks, Contingencies and Unusual Items
- Interest expense rose sharply because of higher debt balances and higher variable interest rates. The company entered into a new $100 million interest-rate swap arrangement effective through June 2025.
- The company has a potential maximum undiscounted obligation of $8.2 million related to guarantees on 50 assigned domestic leases; management considers payment not probable.
- A delivery-driver wage and expense reimbursement settlement received final court approval after quarter-end. The settlement amount is capped at $20.0 million, subject to claims, with $5.0 million accrued and funded as of June 25, 2023.
- A separate $5.0 million antitrust settlement remains accrued and is subject to court approval and customary contingencies.
- Key risks include inflation, labor and food costs, supply-chain disruptions, UK and other international conditions, foreign-currency volatility, interest rates, indebtedness, cyberattacks, litigation, food safety and changes in consumer demand.
- The company’s stockholders’ deficit was $465.5 million at June 25, 2023, compared with $270.7 million at year-end 2022, primarily reflecting share repurchases and related financing activity.
Important Facts for Investors to Verify
- Whether UK company-owned restaurants produce the expected sales, margin and operating efficiencies, and whether additional UK acquisitions are pursued.
- Whether North America franchised comparable sales recover from declines and support royalty and commissary revenue growth.
- The sustainability of cash flow and dividend payments after elevated share repurchases, higher debt and increased interest costs.
- Compliance with leverage and interest-coverage covenants as debt balances and interest rates change.
- The final accounting and cash cost of the driver settlement and the court status of the separate antitrust settlement.
- Progress toward the 270-to-310 net new unit target and the revised 2022-to-2025 development outlook.
