PAPA JOHNS INTERNATIONAL INC annual report, FY2023

Papa John’s International, Inc. — Fiscal 2023 Form 10-K Summary

Business context and reporting period

Papa John’s operates and franchises pizza delivery, carryout and, in certain international markets, dine-in restaurants. At December 31, 2023, the system had 5,906 restaurants in 50 countries and territories, including 648 company-owned and 5,258 franchised locations. The company reports four primary segments: Domestic Company-owned restaurants, North America franchising, North America commissaries and International.

Fiscal 2023 ended December 31, 2023 and included 53 weeks, compared with 52 weeks in fiscal 2022, which affects year-over-year comparability. The filing was audited by Ernst & Young LLP with unqualified opinions on the financial statements and internal control over financial reporting.

Financial performance and key metrics

Metric	FY 2023	FY 2022	Change
Total revenue	$2.136 billion	$2.102 billion	1.6%
Operating income	$147.1 million	$109.0 million	$38.1 million increase
Operating margin	6.9%	5.2%	170 basis-point increase
Net income attributable to the company	$82.1 million	$67.8 million	21.1% increase
Diluted EPS	$2.48	$1.89	$0.59 increase
Adjusted diluted EPS	$2.71	$2.94	$0.23 decrease
Cash flow from operations	$193.1 million	$117.8 million	$75.2 million increase
Free cash flow	$116.4 million	$39.4 million	$77.0 million increase

Revenue growth benefited from the additional fiscal week, higher Domestic Company-owned sales, franchise royalties and the acquisition of 118 formerly franchised UK restaurants. These benefits were partly offset by lower North America commissary revenue due to lower commodity prices and volumes, the 2022 refranchising activity and the sale of Preferred Marketing Solutions.

Domestic Company-owned restaurant revenue was $726.4 million, up 2.5%; comparable sales increased 3.4%.
North America franchise royalties and fees were $144.6 million, up 5.2%; comparable franchised sales increased 0.1%.
North America commissary revenue was $852.4 million, down 2.0%; excluding the extra week and 2022 refranchising, management estimated a 5.0% decline.
International revenue was $157.2 million, up 21.0%, primarily reflecting the UK acquisitions; International comparable sales declined 3.1%.
Global system-wide restaurant sales increased 5.0%, while total comparable sales declined 0.1%.
Reported adjusted operating income was $157.0 million, essentially flat with $157.5 million in 2022. The extra week contributed approximately $8 million.

Liquidity, debt and capital allocation

Cash and cash equivalents were $40.6 million at year-end, compared with $47.4 million at December 25, 2022.
Total debt was $764.0 million, consisting of $400.0 million of 3.875% senior notes due 2029 and $364.0 million drawn under the $600.0 million revolving credit facility.
Remaining revolving-facility availability was $236.0 million. The company was in compliance with its financial covenants, with a 3.2-to-1.0 leverage ratio versus a 5.25-to-1.0 maximum and a 3.3-to-1.0 interest coverage ratio versus a 2.00-to-1.0 minimum.
Net interest expense increased to $43.5 million from $25.3 million, primarily because of higher borrowings and interest rates.
The company repurchased 2.523 million shares for $209.6 million in 2023, including approximately 2.2 million shares purchased from funds affiliated with Starboard Value at $82.52 per share. Approximately $90.2 million remained available under the authorization as of February 22, 2024.
Common dividends paid were $58.5 million, or $1.76 per share. A first-quarter 2024 dividend of $0.46 per share was declared and paid in February 2024.
Planned 2024 capital expenditures are approximately $75 million to $85 million, primarily for company-owned restaurant development and technology.

Material changes versus the prior comparable period

The 53rd fiscal week increased 2023 revenue by approximately $41 million and operating income by approximately $8 million.
The company acquired 118 UK restaurants in 2023, creating a company-owned International portfolio. Those restaurants generated operating losses and reduced International adjusted operating income by approximately $9 million versus the prior-year franchise model.
System-wide restaurants increased by 208, or 3.7%, to 5,906. North America added 57 net units and International added 151 net units.
Reported operating income improved partly because 2022 included a $12.1 million refranchising and impairment loss; adjusted operating income was slightly lower in 2023.
Interest expense rose substantially because share repurchases were partly funded with revolving debt and borrowing rates increased.
The company sold Preferred Marketing Solutions in October 2023 for $0.6 million upfront consideration plus a percentage of future revenues; no material gain or loss was recognized.
Stockholders’ deficit increased to $443.6 million, primarily reflecting share repurchases and dividends, despite positive earnings.

Guidance, outlook, commentary and unusual items

Management expects North America net unit development in 2024 to increase by more than 20% relative to 2023 net openings.
Management expects more than 100 gross International openings in 2024 but cautions that strategic closures could offset openings, particularly in underperforming markets.
Beginning in 2024, Domestic QC Center fixed operating margins will increase from 4% in 2023 to 8% in 2027, in annual 100-basis-point increments. The company estimates this represents approximately 100 basis points of restaurant-level cost, partly mitigated by volume-based franchisee rebates.
Domestic marketing contributions to the national marketing fund will increase by 100 basis points of sales, while local marketing becomes optional for franchisees.
The company initiated an International Transformation Plan, including regional hubs, increased technology investment and UK business-model changes. It recorded $2.2 million of restructuring costs in 2023 and expects total approved transformation costs of approximately $3 million to $6 million.
In February 2024, the board approved closure of approximately 50 underperforming UK company-owned restaurants during the first six months of 2024. Expected 2024 restructuring charges are approximately $10 million to $15 million, primarily non-cash lease and fixed-asset impairments, severance and related costs. Additional closures and charges remain possible.
Other unusual 2023 items included $4.2 million of UK repositioning and acquisition costs, a $0.9 million Middle East-related receivable reserve, $0.6 million of legal settlement costs and $2.0 million of executive transition costs.

Principal risks and contingencies

UK operations face inflation, elevated interest rates, weak sales, lease exposure and financially pressured franchisees.
International results are exposed to geopolitical conflicts, boycotts, currency fluctuations, sanctions, franchisee financial weakness and regulatory differences. Corporate support for 188 Russian franchised restaurants remains suspended.
Competition, promotional pricing, consumer spending pressure and changing preferences could reduce sales, royalties and margins.
Food, cheese, labor, delivery, insurance and energy costs remain material risks. The company relies on Leprino Foods as its sole domestic mozzarella supplier and has a sole source for garlic sauce.
Digital ordering and third-party technology systems are critical; cybersecurity incidents, outages or data privacy violations could harm revenue, reputation and financial results. Management reported no material cybersecurity incident affecting the company during the prior three years.
Debt and variable-rate borrowing create refinancing, covenant and interest-rate risks. Interest-rate swaps hedge a portion of the revolving debt through June 30, 2025.
The company had $56.8 million of insurance reserves, $16.1 million of allowance for franchisee notes receivable and $37.6 million of valuation allowances against deferred tax assets at year-end.
A proposed $5.0 million settlement in the employee and franchise employee antitrust litigation remained accrued and subject to court approval.
The company is contingently liable for approximately $7.3 million of undiscounted lease payments if certain North American franchisees default, and had $20.7 million of surety bonds outstanding.

Investor verification checklist

Reconcile reported growth with the 53rd-week benefit, UK acquisitions and the 2022 refranchising impact.
Assess whether UK company-owned restaurants can become profitable after the planned closures and transformation program.
Monitor debt repayment, interest expense, revolving-facility availability and covenant headroom.
Evaluate the economics of higher commissary margins, franchisee rebates and increased national marketing contributions.
Compare GAAP EPS of $2.48 with adjusted EPS of $2.71 and review the adjustments underlying the difference.
Track comparable sales, franchisee financial health, net unit growth and the balance between International openings and closures.
Review exposure to cheese and other commodity costs, labor inflation, supply concentration, foreign exchange and geopolitical disruptions.
Verify the timing and ultimate cost of the proposed UK closures, including lease and fixed-asset impairments.