Papa John’s International, Inc. — Q3 2018 Form 10-Q Summary
Business context and reporting period
The filing covers the quarter and nine months ended September 30, 2018, compared with September 24, 2017. Papa John’s operated 5,247 restaurants at quarter-end, including 647 company-owned and 4,600 franchised restaurants across the United States and 46 international countries and territories.
Key financial metrics
| Metric | Q3 2018 | Q3 2017 | 9M 2018 | 9M 2017 |
|---|---|---|---|---|
| Total revenue | $364.0 million | $431.7 million | $1,199.3 million | $1,315.8 million |
| Operating income | $(14.0) million | $33.5 million | $38.7 million | $114.4 million |
| Income before taxes | $(20.0) million | $30.9 million | $22.1 million | $108.3 million |
| Net income attributable to the Company | $(13.0) million | $21.8 million | $15.5 million | $73.8 million |
| Diluted EPS | $(0.41) | $0.60 | $0.47 | $2.02 |
| Operating cash flow | Not separately provided for the quarter | Not separately provided for the quarter | $98.8 million | $114.9 million |
| Free cash flow | Not separately provided for the quarter | Not separately provided for the quarter | $68.2 million | $71.7 million |
- Q3 revenue declined 15.7% and nine-month revenue declined 8.8%. Domestic company-owned restaurant sales decreased 19.4% in Q3 and 12.5% for the nine months, driven by comparable-sales declines of 13.2% and 8.7%, respectively, and restaurant refranchising.
- North America franchise royalties and fees decreased 49.9% in Q3 and 22.9% for the nine months, reflecting approximately $9.9 million of franchise royalty reductions and lower comparable sales.
- Domestic company-owned restaurant operating margin fell to 14.2% in Q3 from 17.5% and to 16.8% for the nine months from 19.2%. International operating margin improved to 40.8% in Q3 from 37.7% and to 38.2% for the nine months from 37.6%.
- The Q3 effective tax rate was a 36.9% benefit, compared with 26.8% expense in the prior-year quarter. The benefit included a $2.4 million tax benefit related to finalization of the 2017 federal tax return.
Liquidity, debt and capital allocation
- Cash and cash equivalents were $24.9 million at September 30, 2018, compared with $22.3 million at December 31, 2017. Total assets were $551.2 million.
- Total debt was $578.6 million, consisting of $380.0 million under the term loan and $198.6 million under the revolving facility. Remaining facility availability, including letters of credit, was approximately $166.4 million.
- The company reported a 3.8-to-1.0 leverage ratio and a 3.3-to-1.0 interest coverage ratio at September 30, 2018 and was in compliance with its amended covenants.
- On October 9, 2018, the credit agreement was amended. The revolving facility maximum was reduced to $400 million, permitted leverage was increased to 5.25-to-1.0 beginning in Q3 2018 and steps down to 4.00-to-1.0 by 2022, and additional restrictions apply to share repurchases and dividend increases when leverage exceeds 3.75-to-1.0.
- Nine-month cash uses included $30.6 million of capital expenditures, $21.9 million of dividends and $158.0 million of share repurchases. The company stated that it did not expect additional repurchases in 2018.
- Quarterly interest rates, including swaps, averaged 3.9% in Q3 2018 and 3.7% for the nine months, versus 2.7% and 2.4% in the comparable 2017 periods.
Material changes versus the prior comparable period
- Results were materially affected by negative publicity and consumer sentiment following statements and actions by founder and former spokesperson John H. Schnatter in July 2018.
- Q3 included $24.8 million of pretax special charges: approximately $9.9 million of franchise royalty reductions, $3.6 million of restaurant reimaging and branded-asset costs, and $11.3 million of legal, professional and advisory costs.
- Management reported Q3 adjusted net income of $6.2 million and adjusted diluted EPS of $0.20, compared with GAAP net loss of $13.0 million and diluted loss per share of $0.41.
- The company adopted ASC Topic 606 using the modified retrospective method. The adoption reduced retained earnings by approximately $21.5 million at January 1, 2018, increased Q3 revenue by $1.5 million and reduced Q3 pretax income by $1.2 million.
- The company refranchised 62 North America company-owned restaurants and 34 China company-owned restaurants during the first nine months. A $1.9 million pretax refranchising loss was recorded, primarily related to China.
- Shares outstanding declined substantially due to repurchases; the company purchased approximately 2.7 million shares for $158.0 million during the first nine months.
Guidance, outlook, risks and unusual items
- Management expected 2018 special charges of approximately $50 million to $60 million, including estimated fourth-quarter charges of approximately $25 million to $35 million. Expected items included franchisee assistance, national marketing-fund contributions, culture-audit costs and additional legal and advisory expenses.
- The company could continue to experience sales declines from negative consumer sentiment and stated that the duration and extent of the impact could not be predicted.
- A Special Committee was overseeing an external culture audit and investigation relating to diversity and inclusion, supplier and vendor engagement and company culture. The investigation was ongoing at the filing date.
- Material litigation included an appeal by Ameranth following summary judgment that invalidated the patent at issue, a conditionally certified delivery-driver reimbursement collective action, securities litigation by investors, and litigation brought by Mr. Schnatter. The company had not recorded liabilities for these matters because losses were not considered probable or reasonably estimable.
- The company had contingent lease obligations related to refranchised restaurants, with estimated maximum undiscounted payments of $3.2 million for Denver and $6.3 million for Minnesota if primary lessees fail to pay.
- Other risks include covenant compliance, interest-rate and commodity-cost volatility, foreign-currency exposure, supply-chain concentration, food safety, litigation, technology and data-security risks, and the ability to restore sales and maintain dividends.
Most important facts for investors to verify
- Whether comparable sales and franchisee restaurant closures stabilize after the Q3 brand disruption.
- The actual amount and duration of special charges, franchisee support and marketing investments beyond 2018.
- Compliance with amended debt covenants and the impact of leverage restrictions on share repurchases and dividends.
- Cash generation relative to debt service, capital expenditures, dividends and future restructuring or brand-investment costs.
- Progress and findings of the external culture audit and any resulting legal, operational or financial consequences.
- The effect of ASC Topic 606 and the planned adoption of lease accounting, which management expected to significantly increase reported non-current assets and liabilities.