Papa John’s International, Inc. — Q2 2020 Form 10-Q Summary
Business context and reporting period
The filing covers the quarter and six months ended June 28, 2020, compared with June 30, 2019. Papa John’s operated 5,347 restaurants in 48 countries and territories at quarter-end, including 598 company-owned and 4,749 franchised locations. The business includes company-owned restaurants, franchise royalties and fees, commissary distribution, international operations, marketing funds, online ordering and related services.
Financial performance and key metrics
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Total revenue | $460.6 million | $399.6 million | $870.5 million | $798.0 million |
| Revenue growth | 15.3% | — | 9.1% | — |
| Operating income | $30.5 million | $14.2 million | $46.0 million | $19.7 million |
| Operating margin | 6.6% | 3.6% | 5.3% | 2.5% |
| Net income attributable to the Company | $20.6 million | $8.4 million | $29.1 million | $6.6 million |
| Diluted EPS | $0.48 | $0.15 | $0.65 | $0.03 |
| Net cash from operating activities | Not separately provided | Not separately provided | $87.7 million | $32.2 million |
| Free cash flow | Not separately provided | Not separately provided | $67.0 million | $8.9 million |
- Q2 revenue increases were led by domestic company-owned restaurant sales of $186.5 million, North America commissary revenue of $167.6 million, North America franchise royalties and fees of $24.2 million, and other revenue of $54.2 million.
- Q2 income before taxes was $26.9 million, or 5.8% of revenue, compared with $10.0 million, or 2.5%, in the prior-year quarter. Six-month income before taxes was $38.4 million, or 4.4% of revenue, versus $9.2 million, or 1.2%.
- Net interest expense declined to $3.6 million in Q2 and $7.6 million for six months, primarily because of lower interest rates and lower average debt balances.
- Cash and cash equivalents were $75.7 million at June 28, 2020, compared with $27.9 million at December 29, 2019. Total assets were $757.7 million.
- Debt outstanding was approximately $350.1 million gross, consisting primarily of the term loan. The company had no borrowings under its $400 million secured revolving facility and approximately $353.8 million of remaining availability, including letters of credit.
- The company’s leverage ratio was 2.9 to 1.0 versus a permitted 5.0 to 1.0, and its interest coverage ratio was 3.3 to 1.0 versus a required minimum of 2.25 to 1.0. The company was in compliance with its debt covenants.
- Stockholders’ deficit was $307.6 million, and total stockholders’ deficit including noncontrolling interests was $291.8 million. Series B convertible preferred stock was reported as temporary equity at $251.8 million.
Material changes versus the prior comparable period
- System-wide North America comparable sales increased 28.0% in Q2, including 22.6% at domestic company-owned restaurants and 29.7% at North America franchised restaurants. International comparable sales increased 5.3%.
- Domestic company-owned restaurant sales increased 14.0% in Q2 and 6.9% for six months. Excluding the effect of 2019 refranchising, growth was 22.0% and 14.6%, respectively.
- North America franchise royalties and fees increased 22.3% in Q2 and 17.0% for six months, while North America commissary revenue increased 13.9% and 9.1%, respectively.
- Total costs and expenses declined as a percentage of revenue to 93.4% from 96.5% in Q2 and to 94.7% from 97.5% for six months, supporting significant operating-margin expansion.
- International segment income before taxes declined $0.8 million in Q2 and $1.6 million for six months, primarily because of royalty support, lower United Kingdom commissary margins and unfavorable foreign exchange.
- Operating cash flow increased $55.5 million year over year for the first six months, benefiting from higher earnings and favorable working-capital timing. Capital expenditures declined to $13.8 million from $17.8 million.
- The company adopted the expected-credit-loss standard ASU 2016-13 on December 30, 2019, recording a $1.1 million after-tax reduction to opening retained earnings.
Guidance, outlook, commentary, risks and unusual items
- Management stated that the delivery and carryout model supported strong demand during COVID-19. It implemented no-contact delivery, enhanced cleaning and sanitization, expanded employee benefits and hired thousands of restaurant team members.
- As of June 28, 2020, 225 of the company’s 2,063 international franchised stores were temporarily closed, principally in Latin America and Europe. Most North American traditional restaurants remained open.
- Preliminary estimated Period 7 comparable sales growth, June 29 through July 26, 2020, was 23.6% for domestic company-owned restaurants, 32.4% for North America franchised restaurants, 30.3% system-wide in North America and 13.9% internationally. These figures were preliminary and included temporarily closed international stores.
- The company stated that it could not predict the specific effects of COVID-19 on future operating results, liquidity or long-term financial condition.
- Temporary franchise support was $5.1 million in Q2 and $15.8 million for six months. The company expected approximately $12 million to $15 million of support in Q3 2020, with the program scheduled to conclude in Q3.
- On July 31, 2020, the board declared a third-quarter common dividend of $0.225 per share and a preferred dividend. Debt agreements restrict dividend increases and share repurchases if leverage exceeds specified thresholds.
- Interest-rate swaps with a $350 million notional value fixed the effective rates on the company’s term debt at rates ranging from 1.99% to 2.36%. The weighted-average borrowing rate, including swaps, was 3.8% in Q2 and for the six-month period.
- Key risks include the duration and severity of COVID-19, temporary store closures, consumer demand changes, supply-chain disruption, labor and commodity costs, foreign exchange, franchisee financial health, cyber and technology risks, litigation, debt refinancing and dividend capacity.
- The company disclosed litigation involving delivery-driver reimbursement claims and a securities class action. No liability was recorded for either matter because management did not believe a loss was probable or reasonably estimable. The maximum undiscounted exposure on approximately 89 assigned domestic leases was estimated at $15.9 million, but the liability was not considered probable.
Important facts for investors to verify
- Whether unusually strong COVID-period comparable sales persisted after the reported Period 7 results and after temporary support ended.
- The number and duration of international and non-traditional restaurant closures, and the financial condition of franchisees.
- Progress on the $350 million term loan, the August 2022 maturity, covenant headroom and the effect of any LIBOR replacement.
- The sustainability of operating-margin improvement after higher labor, incentive, commodity and franchise-support costs.
- Cash flow conversion after dividends, capital expenditures, preferred dividends and required debt amortization.
- Potential obligations from litigation, lease guarantees, interest-rate swaps and other contingencies not fully reflected in reported liabilities.
- The effect of the Series B preferred stock, including dividends, participating rights and potential dilution, on common-shareholder returns.