Papa John’s International, Inc. — Q1 2019 Form 10-Q Summary
Business Context and Reporting Period
Results cover the three months ended March 31, 2019, compared with the three months ended April 1, 2018. Papa John’s operated 5,336 restaurants at quarter-end: 645 company-owned and 4,691 franchised, across all 50 U.S. states and 47 international countries and territories. Revenue is generated primarily from company-owned restaurants, franchise royalties and fees, commissary sales, international operations, marketing-fund contributions, and related services.
Key Financial Metrics
| Metric | Q1 2019 | Q1 2018 | Change |
|---|---|---|---|
| Total revenue | $398.4 million | $450.1 million | Down 11.5% |
| Operating income | $5.5 million | $28.1 million | Down $22.6 million |
| Operating margin | 1.4% | 6.3% | Down 4.9 percentage points |
| Loss before income taxes | $0.8 million | Income of $23.1 million | Unfavorable $23.8 million |
| Net loss attributable to the Company | $1.7 million | Net income of $17.4 million | Unfavorable $19.2 million |
| Net loss attributable to common shareholders | $3.8 million | Net income of $17.4 million | Unfavorable $21.2 million |
| Diluted EPS | $(0.12) | $0.52 | Down $0.64 |
| Cash flow from operations | $13.8 million | $36.7 million | Down $22.9 million |
| Free cash flow | $3.1 million | $27.4 million | Down $24.3 million |
- Domestic company-owned restaurant sales were $161.8 million, down 14.9%, driven by a 9.0% comparable-sales decline and a 7.5% reduction in equivalent units following refranchising activity.
- North America franchise royalties and fees were $17.5 million, down 29.3%, reflecting a 6.1% comparable-sales decline and $4.9 million of short-term royalty reductions provided to franchisees.
- North America commissary sales declined 7.9% to $148.9 million, while the commissary margin improved to 6.9% from 6.2%.
- International revenue declined 14.8% to $25.7 million, partly because of prior refranchising transactions and a $1.7 million unfavorable foreign-exchange impact. International franchise sales increased 10.5% excluding foreign currency.
- Domestic company-owned restaurant margin improved to 17.8% from 17.2%, despite lower sales, due principally to favorable commodity, workers’ compensation, and insurance costs.
- General and administrative expense increased to $51.1 million from $40.0 million, including $5.6 million related to the Starboard option valuation and $5.1 million of Special Committee costs.
Liquidity, Debt, and Capital Structure
- Cash and cash equivalents were $29.3 million at March 31, 2019, compared with $33.3 million at December 30, 2018.
- Total debt was approximately $380.0 million, including $370.0 million under the secured term loan and $10.0 million under the Papa John’s Marketing Fund revolving facility. No borrowings were outstanding under the principal revolving facility.
- Remaining availability under the principal credit facilities was approximately $360.0 million, including outstanding letters of credit. The facilities mature August 30, 2022.
- The Company used proceeds from its Series B preferred-stock issuance primarily to repay revolving debt. Debt declined by approximately $245.0 million from year-end 2018.
- Series B Convertible Preferred Stock with an investment value of approximately $252.5 million was outstanding at quarter-end, classified as temporary equity. The stock carries a 3.6% annual dividend, participates in common dividends on an as-converted basis, and is convertible at a $50.06 conversion price.
- The Company paid approximately $9.1 million in dividends during the quarter, including $7.1 million to common shareholders and approximately $2.0 million to preferred shareholders. A $0.225 common dividend was declared for the second quarter.
- Leverage and interest-coverage ratios were 3.0-to-1.0 and 2.7-to-1.0, respectively, versus permitted maximum or minimum thresholds of 5.25-to-1.0 and 2.0-to-1.0. The Company reported compliance with all debt covenants.
Material Changes and Unusual Items
- The Company issued $252.5 million of Series B preferred stock, including $250.0 million to Starboard and $2.5 million to certain franchisees. Issuance costs were approximately $7.2 million.
- Q1 2019 Special charges totaled $15.9 million, comprising approximately $4.9 million of franchisee royalty relief, $5.1 million of legal and advisory costs, and $5.9 million of noncash mark-to-market adjustments related to preferred-stock options.
- Excluding Special charges, adjusted net income attributable to common shareholders was $9.7 million and adjusted diluted EPS was $0.31, compared with $17.4 million and $0.52, respectively, in Q1 2018.
- The Company began consolidating Papa John’s Marketing Fund, Inc. after determining that it controlled the fund as a variable-interest entity. Prior-period financial statements were restated for this immaterial error correction, increasing reported Q1 2018 revenue by $22.8 million and reported total assets at December 30, 2018 by $25.0 million.
- The Company adopted the new lease standard at the beginning of fiscal 2019. At March 31, 2019, it reported $150.2 million of right-of-use assets and $152.9 million of present-value lease liabilities, excluding certain held-for-sale amounts.
- Approximately 40 company-owned stores and related properties were classified as held for sale, with $10.8 million of assets and $4.1 million of liabilities classified accordingly.
- The prior share-repurchase program expired February 27, 2019. No open-market share repurchases occurred during the quarter.
Guidance, Outlook, Risks, and Contingencies
- Management stated that it expects the annual effective tax rate to be approximately 21% to 24%.
- Based on April 30, 2019 futures prices, management projected a 2019 average cheese block price of approximately $1.636 per pound, versus $1.552 in 2018, before the impact of certain forward-pricing agreements.
- Management expects expanded revolving-credit availability to support investment in the business and general corporate purposes, but continued sales weakness, franchisee financial assistance, and brand-recovery costs could pressure cash flow and dividends.
- The Company identified material weaknesses in internal controls related to PJMF consolidation. Disclosure controls were not effective at quarter-end; remediation was underway but had not yet operated long enough to be considered complete.
- Key risks include negative consumer sentiment, declining comparable sales, franchisee financial condition, competitive pricing and promotions, food and labor-cost inflation, supply-chain concentration, foreign-exchange and Brexit-related risks, interest-rate and LIBOR transition risks, cybersecurity, and food-safety events.
- The Company had no recorded liability for the Ameranth patent litigation or the Durling driver-expense collective action because management did not consider a loss probable or reasonably estimable. The Ameranth case remained stayed pending appeal, and 9,571 drivers had opted into the Durling action.
- In April 2019, the Company terminated two interest-rate swaps totaling $50 million of notional value, leaving $350 million of swap notional outstanding.
Investor Verification Checklist
- Verify the sustainability of comparable-sales trends, restaurant-level margins, and the effect of franchisee royalty relief.
- Reconcile GAAP results with management’s adjusted results and assess whether Special charges are truly nonrecurring.
- Review the Series B preferred-stock conversion, dividend, redemption, voting, and change-of-control provisions and their potential dilution to common shareholders.
- Monitor debt covenant headroom, required term-loan amortization, the December 2019 PJMF facility maturity, and available liquidity.
- Track remediation of the material weaknesses involving PJMF consolidation and related SEC reporting controls.
- Assess the potential financial and operational effects of pending litigation, franchisee assistance, store refranchising, and the company’s brand-recovery initiatives.