Papa John’s International, Inc. — Q2 2017 Form 10-Q Summary
Business context and reporting period
The filing covers the three and six months ended June 25, 2017, compared with June 26, 2016. Papa John’s operated 5,088 restaurants at quarter-end, including 744 company-owned and 4,344 franchised restaurants across the United States and 44 international countries and territories. Revenue is generated from company-owned restaurant sales, franchise royalties and fees, commissary and other sales, and international operations.
Financial performance and liquidity
| Metric | Three months ended June 25, 2017 | Three months ended June 26, 2016 | Six months ended June 25, 2017 | Six months ended June 26, 2016 |
|---|---|---|---|---|
| Total revenue | $434.8 million | $423.0 million | $884.0 million | $851.6 million |
| Operating income | $37.2 million | $36.8 million | $80.9 million | $79.7 million |
| Income before taxes | $35.5 million | $35.2 million | $77.3 million | $76.6 million |
| Net income attributable to the Company | $23.5 million | $22.5 million | $52.0 million | $48.7 million |
| Diluted EPS | $0.65 | $0.61 | $1.42 | $1.29 |
| Operating cash flow | Not separately provided | Not separately provided | $77.9 million | $79.6 million |
| Free cash flow | Not separately provided | Not separately provided | $47.4 million | $55.6 million |
Revenue increased 2.8% in the quarter and 3.8% year to date. Operating margin was approximately 8.6% in the quarter and 9.2% year to date, compared with approximately 8.7% and 9.4% in the respective prior-year periods. Net income attributable to the Company increased 4.4% in the quarter and 6.7% year to date. Diluted EPS increased 6.6% and 10.1%, respectively, aided by higher earnings and lower shares outstanding from repurchases.
At June 25, 2017, cash and cash equivalents were $22.2 million, compared with $15.6 million at December 25, 2016. Long-term debt, net, was $305.1 million, consisting entirely of borrowings under a $500 million unsecured revolving credit facility. Remaining availability, including the effect of outstanding letters of credit, was approximately $164.2 million. The company was in compliance with its debt covenants; its leverage ratio was 1.6-to-1.0 versus a maximum of 3.0-to-1.0, and its interest coverage ratio was 4.8-to-1.0 versus a minimum of 3.5-to-1.0.
Capital expenditures were $30.5 million in the first six months, primarily including construction costs for a new Georgia commissary. The company paid $14.7 million in dividends and repurchased $34.0 million of common stock during the period.
Material changes versus the prior comparable period
- Domestic company-owned restaurant sales declined 0.7% in the quarter and 0.1% year to date, primarily because equivalent units declined following the refranchising of 42 restaurants in the fourth quarter of 2016. Comparable sales increased 2.3% and 2.7%, respectively.
- North America franchise royalties and fees increased 5.1% in the quarter and 4.7% year to date, supported by comparable sales and unit growth.
- North America commissary and other sales increased 6.2% in the quarter and 8.2% year to date, driven by higher volumes and commodity costs. The related margin declined to 7.0% from 7.7% in the quarter and to 6.8% from 7.4% year to date, primarily due to start-up costs for the Georgia commissary.
- International revenue increased 6.2% in the quarter and 5.1% year to date, while international operating margin declined to 35.6% from 37.6% in the quarter and to 36.2% from 36.8% year to date, primarily due to lower U.K. commissary margins and higher commodity costs.
- General and administrative expense declined $0.6 million in the quarter and $2.9 million year to date, primarily due to lower incentive compensation, bad debt expense, and international advertising timing.
- The effective tax rate declined to 29.5% from 31.5% in the quarter and to 29.0% from 31.9% year to date, partly because of the adoption of new share-based compensation accounting guidance.
- Operating cash flow decreased $1.7 million year to date, while free cash flow declined $8.2 million because of higher capital expenditures.
Guidance, outlook, risks, contingencies, and unusual items
The filing does not provide a specific full-year revenue or earnings guidance figure. Management expected the new Georgia commissary to open in July 2017. The company also expected to repurchase the full amount of an increased share repurchase authorization within approximately 12–18 months, funded through planned new debt facilities expected to be executed before the end of 2017.
On July 27, 2017, the board increased the share repurchase authorization by $500 million to $2.075 billion and extended it to February 27, 2019. Approximately $590.2 million remained available as of that date. The board also increased the annualized dividend rate by 12.5%, from $0.80 to $0.90 per share, and declared a third-quarter dividend of $0.225 per share.
Key risks include competitive pricing and promotions, changes in consumer demand, food and labor cost inflation, insurance claims, supply-chain disruption including reliance on limited suppliers, international economic and currency risks, Brexit-related uncertainty, litigation, food safety issues, information technology and data security failures, regulatory changes, succession planning, and the ability to obtain additional debt on favorable terms. The company reported no material changes to previously disclosed risk factors and stated that its disclosure controls were effective.
The company is involved in ordinary-course litigation, claims, investigations, and proceedings, including intellectual property, employment, consumer, and commercial matters. The filing does not identify a separate material litigation contingency. The company adopted ASU 2016-09 in 2017 and expects to adopt the new revenue recognition standard in the first quarter of 2018; the company preliminarily expects a modified retrospective transition method.
Important facts for investors to verify
- Whether the planned new debt facilities are executed and how they affect leverage, interest expense, and liquidity.
- Progress, costs, and operating performance of the Georgia commissary after its July 2017 opening.
- Whether domestic company-owned restaurant margins recover from higher insurance and delivery-related costs.
- International margin trends, foreign currency effects, and exposure to Brexit-related trade and regulatory changes.
- The pace and valuation of share repurchases relative to cash flow and the enlarged authorization.
- The impact of the 2018 revenue recognition adoption on loyalty programs, advertising funds, and franchise and development fees.
- Commodity costs, particularly cheese prices, and the company’s ability to offset inflation through pricing and operating efficiencies.