Papa John’s International, Inc. — Fiscal 2019 Form 10-K Summary
Business context and reporting period
For the 52-week fiscal year ended December 29, 2019, Papa John’s operated and franchised pizza delivery and carryout restaurants in 49 countries and territories. The system had 5,395 restaurants at year-end: 598 company-owned and 4,797 franchised. Reportable segments were domestic company-owned restaurants, North America commissaries, North America franchising, and international operations.
The filing describes a strategic turnaround following negative publicity and declining North America sales. Priorities included restoring brand strength, improving unit economics, expanding digital capabilities, supporting franchisees, and increasing international unit growth.
Key financial metrics
| Metric | 2019 | 2018 | Change |
|---|---|---|---|
| Total revenues | $1.619 billion | $1.663 billion | Down 2.6% |
| Operating income | $24.5 million | $31.6 million | Down 22.2% |
| Income before taxes | $5.0 million | $6.7 million | Down 24.7% |
| Net income attributable to the Company | $4.9 million | $2.5 million | Up from low base |
| Net loss attributable to common shareholders | $7.6 million | $2.5 million income | Impacted by preferred dividends and accretion |
| Diluted EPS | $(0.24) | $0.08 | Declined |
| Adjusted diluted EPS | $1.17 | $1.37 | Down 14.6% |
| Cash flow from operations | $61.7 million | $92.5 million | Down $30.7 million |
| Free cash flow | $14.0 million | $50.4 million | Down $36.4 million |
| Total debt | $370.0 million | $625.0 million | Down $255.0 million |
| Cash and cash equivalents | $27.9 million | $33.3 million | Down $5.3 million |
Operating margin was approximately 1.5%, compared with 1.9% in 2018. Income before taxes was only approximately 0.3% of revenue. Adjusted income before taxes, excluding special items, increased 5.9% to $61.1 million.
Domestic company-owned comparable sales declined 2.7%, North America franchised comparable sales declined 2.0%, and international system-wide comparable sales increased 1.1%. More than 60% of domestic sales were generated through digital channels.
Year-end liquidity included approximately $27.9 million of cash and approximately $343.8 million of remaining availability under the secured credit facilities, including the effect of outstanding letters of credit. The company was in compliance with its debt covenants; its reported leverage ratio was 3.5-to-1.0 versus a permitted maximum of 5.25-to-1.0, and its interest coverage ratio was 2.7-to-1.0 versus a minimum of 2.0-to-1.0.
Material changes versus the prior comparable period
- Revenue declined primarily because of lower domestic company-owned sales, lower North America franchise royalties, unfavorable foreign currency effects, and restaurant refranchising.
- Domestic company-owned restaurant sales decreased 5.8%, while North America franchise royalties and fees decreased 9.4%. Commissary revenue increased 0.5%, and other revenue increased 5.2%, partly from higher marketing fund contributions and online revenue.
- Adjusted pretax income increased $3.4 million despite lower comparable sales, reflecting improved company-owned restaurant costs, lower insurance costs, lower advertising expense, and reduced interest expense.
- Special charges increased to $60.8 million from $50.7 million. Major 2019 items included $27.5 million of marketing fund investments, $19.1 million of royalty relief, $5.9 million of legal and advisory costs, and a $5.9 million preferred-stock option mark-to-market adjustment.
- Debt declined after the company used net proceeds from the $252.5 million issuance of Series B Convertible Preferred Stock to repay revolving borrowings. The preferred stock was recorded as temporary equity at $251.1 million at year-end.
- The company refranchised 46 primarily Georgia and South Florida company-owned restaurants, generating a $4.7 million net refranchising gain and reducing the company-owned restaurant count from 645 to 598.
- International restaurants increased by 141 net units to 2,107, while total system restaurants increased by 92 to 5,395. North America restaurants declined by 49 net units.
- The 2018 financial statements were restated to consolidate Papa John’s Marketing Fund, Inc. as a variable interest entity. Management reported that the related material weakness in internal control was remediated in 2019.
Guidance, outlook, commentary, risks and unusual items
- Management expected $25 million to $30 million of additional special charges in 2020 for franchisee assistance, royalty relief, and marketing investments.
- North America comparable sales turned positive in the third and fourth quarters of 2019 after being negative since the fourth quarter of 2017. Management presented this as an early indicator of turnaround progress, not a guarantee of sustained improvement.
- The company appointed Robert Lynch as CEO in August 2019 and restructured executive management in November 2019. The CFO was expected to depart in March 2020, with an interim principal financial and accounting officer designated.
- Series B Preferred Stock carries a 3.6% initial dividend, participates in common dividends on an as-converted basis, is convertible at a stated conversion price of $50.06, and may become redeemable after the eight-year anniversary of issuance. It also gives Starboard governance, consent, and director-designation rights.
- The company continues to face reputational and litigation risks related to prior negative publicity, including a securities class action and litigation involving its former founder. The filing states that no liability was recorded for the disclosed securities litigation because a loss was not considered probable or reasonably estimable.
- Approximately 50 franchised stores in China were closed because of the coronavirus outbreak as of the filing date. Management stated that the immediate impact was not material but identified substantial uncertainty regarding potential future effects.
- Key operating risks include competition, food and labor inflation, minimum-wage increases, delivery aggregators, dependence on suppliers including a primary cheese supplier, franchisee financial health, foreign exchange, cybersecurity, privacy regulation, litigation, and potential LIBOR transition effects.
- The company had $19.2 million of maximum potential undiscounted obligations under guarantees of certain franchisee leases, $46.2 million of standby letters of credit, and $40.8 million of net franchisee loans outstanding.
Most important facts for an investor to verify
- Whether positive North America comparable sales continued and translated into sustainable franchisee profitability.
- The actual 2020 amount and cash impact of franchisee assistance, royalty relief, marketing investments, and other special charges.
- Whether the company can maintain dividends while generating only modest free cash flow and carrying $370 million of debt plus preferred-stock obligations.
- The terms, conversion dilution, dividend escalation, and potential redemption funding requirements of the Series B Preferred Stock.
- Compliance with leverage and interest-coverage covenants as operating results and special charges evolve.
- The financial condition of franchisees, collectability of the $40.8 million franchisee loan balance, and exposure to additional franchisee support.
- The effect of coronavirus-related closures, foreign exchange, commodity prices, labor costs, and supply-chain disruptions on 2020 results.
- The status and potential cost of disclosed securities, employment, delivery-driver, and other litigation.
- Whether the PJMF consolidation restatement, remediation of internal-control weaknesses, and 2019 auditor change have any continuing reporting implications.