Papa John’s International, Inc. — FY2017 Form 10-K Summary
Business context and reporting period
Papa John’s operates and franchises pizza delivery and carryout restaurants, with dine-in locations in certain international markets. The filing covers the 53-week fiscal year ended December 31, 2017, compared with the 52-week year ended December 25, 2016. At year-end, the system had 5,199 restaurants: 743 company-owned and 4,456 franchised, across all 50 U.S. states and 44 international countries and territories.
Revenue is generated from company-owned restaurant sales, franchise royalties and fees, North America commissary and other sales, and international operations. More than 60% of domestic sales were placed through digital channels in 2017.
Key financial metrics
| Metric | 2017 | 2016 | Change |
|---|---|---|---|
| Total revenue | $1.783 billion | $1.714 billion | +4.1% |
| Operating income | $151.0 million | $164.5 million | -8.2% |
| Income before taxes | $140.3 million | $158.8 million | -11.6% |
| Net income attributable to the Company | $102.3 million | $102.8 million | -0.5% |
| Diluted EPS | $2.83 | $2.74 | +3.3% |
| Operating margin | 8.5% | 9.6% | -1.1 percentage points |
| Cash flow from operations | $135.0 million | $150.3 million | -$15.3 million |
| Free cash flow | $82.4 million | $94.7 million | -$12.3 million |
| Total debt | $470.0 million | $300.6 million | +$169.4 million |
Adjusted diluted EPS was $2.62, compared with $2.55 in 2016. Excluding the 53rd week, adjusted diluted EPS was $2.51 versus $2.55. The 53rd week contributed approximately $30.9 million of revenue, $5.9 million of pretax income, and $0.11 of diluted EPS.
- Domestic company-owned restaurant sales were $816.7 million, up 0.1%; comparable sales increased 0.4%.
- North America franchise royalties and fees were $106.7 million, up 3.6%; comparable franchise sales decreased 0.1%.
- North America commissary and other sales were $733.6 million, up 7.6%.
- International revenue was $126.3 million, up 11.7%, including a $4.1 million unfavorable foreign-exchange impact; international comparable sales increased 4.4% on a constant-dollar basis.
- Domestic company-owned restaurant margin declined to 18.6% from 20.2%, primarily due to higher automobile and workers’ compensation insurance costs, commodities, and labor costs.
- North America commissary margin declined to 6.6% from 7.4%, largely because of start-up and operating costs for the new Georgia commissary.
- International operating margin increased to 37.5% from 36.8%.
Material changes versus the prior comparable period
- Restaurant count increased by 102 net units, from 5,097 to 5,199. The Company opened 376 restaurants and closed 274, compared with 343 openings and 139 closures in 2016.
- International restaurants increased from 1,614 to 1,758, while North America restaurants increased from 3,441 to 3,441 because higher openings were offset by closures.
- Company-owned domestic restaurant count increased from 702 to 708; international company-owned units declined from 42 to 35.
- Interest expense increased to $11.3 million from $7.4 million due to higher debt balances and interest rates.
- General and administrative expense decreased to $158.2 million from $163.8 million, primarily due to lower incentive and restaurant supervisor bonus costs.
- 2016 included an $11.6 million pretax gain from refranchising the Phoenix market and a favorable $0.9 million legal settlement adjustment; 2017 included neither item.
- 2017 included a $1.7 million impairment charge related to the China company-owned operations held for sale, compared with a $1.4 million charge in 2016.
- The Tax Cuts and Jobs Act produced a provisional one-time tax benefit of approximately $7.0 million in the fourth quarter and reduced the effective tax rate to 24.1% from 31.3%.
- Share repurchases increased to approximately 3.0 million shares costing $209.6 million, compared with 2.1 million shares costing $122.4 million in 2016. Dividends declared increased to $0.85 per share from $0.75.
Liquidity, debt, and capital allocation
Cash and cash equivalents were $22.3 million at December 31, 2017, compared with $15.6 million at the prior year-end. The Company entered into a new unsecured credit agreement providing a $600 million revolving facility and a $400 million term loan facility. Outstanding borrowings were $395 million under the term loan and $75 million under the revolver, with approximately $493 million of remaining availability including letters of credit.
The facilities mature August 30, 2022, and require quarterly term-loan amortization of $5 million beginning in the fourth quarter of 2017. The Company was in compliance with its covenants, reporting a 2.4-to-1.0 leverage ratio versus a permitted maximum of 4.5-to-1.0 and a 4.3-to-1.0 interest coverage ratio versus a required minimum of 2.75-to-1.0. Interest-rate swaps hedge portions of the variable-rate debt.
2017 contractual obligations included $470.0 million of debt principal, $94.4 million of estimated interest payments, and $214.1 million of operating lease payments. The Company also had $32.0 million of standby letters of credit and an estimated maximum exposure of $4.4 million under lease guarantees for certain franchisees.
Guidance, outlook, management commentary, risks, and unusual items
- Management expected a 2018 effective tax rate of approximately 20% to 24%, although the Tax Act accounting remained provisional and subject to further guidance.
- The Company had development agreements for approximately 200 additional North America restaurants and approximately 990 additional international franchised restaurants. Management cautioned that scheduled openings may not occur.
- The Company planned to sell its 35 company-owned China restaurants and China QC Center during 2018. The China operations incurred a $2.9 million pretax loss in 2017.
- Management anticipated continuing quarterly dividends and expected to repurchase shares under the remaining authorization, but future dividends and repurchases were subject to board discretion, financial performance, cash needs, and market conditions.
- Management identified risks from intense competition, delivery aggregators, changing consumer preferences, food and cheese costs, labor and insurance inflation, supply-chain concentration, international currency and geopolitical exposure, regulatory changes, cybersecurity, litigation, and franchisee financial performance.
- Lease accounting guidance effective in fiscal 2019 was expected to significantly increase reported noncurrent assets and liabilities because of the Company’s substantial operating lease portfolio.
- New revenue-recognition guidance adopted January 1, 2018 was expected to produce a pretax reduction to opening retained earnings of approximately $20 million to $25 million, primarily related to loyalty programs, franchise and development fees, and advertising-fund presentation.
- Steve Ritchie became President and Chief Executive Officer effective January 1, 2018, succeeding the prior CEO role held by Founder John Schnatter. The filing also disclosed that CFO Lance Tucker was scheduled to depart effective March 2, 2018.
Most important facts for investors to verify
- Whether comparable sales and restaurant-level margins improve after the 2017 slowdown, particularly in North America.
- The effect of $470 million of debt and variable-rate exposure on earnings, cash flow, and share-repurchase capacity.
- Whether the planned China divestiture closes on expected terms and eliminates associated losses and impairment risk.
- Actual 2018 tax rates and any revisions to the provisional Tax Act accounting.
- The pace, profitability, and financing of planned domestic and international franchise openings.
- Trends in cheese, labor, insurance, delivery, and other operating costs, including the impact on franchisee health.
- Execution of the CEO transition and CFO succession, including implications for brand management and strategy.
- Potential effects of litigation, cybersecurity events, food-safety issues, regulatory changes, foreign exchange, Brexit, and lease-accounting adoption.