Papa John’s International, Inc. — 2019 Q2 Form 10-Q Summary
Business context and reporting period
Filed August 6, 2019, for the quarter and six months ended June 30, 2019, with comparisons to July 1, 2018. Papa John’s operated 5,345 restaurants at quarter-end: 643 company-owned and 4,702 franchised, across all 50 states and 47 international countries and territories. Revenue is generated from company-owned restaurants, franchise royalties and fees, commissary sales, marketing funds, technology and other services.
The financial statements were restated to consolidate Papa John’s Marketing Fund, Inc. (PJMF), following the Company’s determination that it controls the fund. The Company also adopted the new lease standard, recognizing significant right-of-use assets and lease liabilities.
Key financial metrics
| Metric | Three months ended June 30, 2019 | Three months ended July 1, 2018 | Six months ended June 30, 2019 | Six months ended July 1, 2018 |
|---|---|---|---|---|
| Total revenue | $399.6 million | $430.0 million | $798.0 million | $880.1 million |
| Operating income | $14.2 million | $24.9 million | $19.7 million | $53.0 million |
| Income before taxes | $10.0 million | $19.1 million | $9.2 million | $42.2 million |
| Net income attributable to the Company | $8.4 million | $11.2 million | $6.6 million | $28.6 million |
| Net income attributable to common shareholders | $4.9 million | $11.1 million | $1.1 million | $28.5 million |
| Diluted EPS | $0.15 | $0.35 | $0.03 | $0.87 |
| Net cash from operating activities | Not separately provided | Not separately provided | $32.2 million | $73.4 million |
| Free cash flow | Not separately provided | Not separately provided | $8.9 million | $51.9 million |
Six-month revenue declined 9.3%, operating income declined 62.8%, and diluted EPS declined 96.6%. The second-quarter effective tax rate was 12.9%, compared with 36.8% in the prior-year quarter; the six-month effective rate was 23.0%.
Domestic company-owned restaurant operating margins improved to 19.4% in the quarter and 18.6% year to date, versus 18.5% and 17.8%, respectively. North America commissary margins improved to 7.1% and 7.0%, versus 6.6% and 6.4%. International margins increased to 42.5% and 43.4%, principally reflecting the prior-year refranchising of China operations.
Liquidity, debt and capital structure
- Cash and cash equivalents were $30.7 million at June 30, 2019, compared with $33.3 million at December 30, 2018.
- Total outstanding debt was $384.2 million, including $373.0 million under the principal secured facilities and $11.2 million of PJMF debt. Principal debt declined $240.7 million from year-end, primarily because Series B preferred-stock proceeds were used to repay revolver borrowings.
- The secured facilities mature August 30, 2022. They comprised a $365.0 million term loan and $8.0 million drawn on a $400.0 million revolving facility. Remaining availability, including letters of credit, was approximately $348.1 million.
- The Company was in compliance with debt covenants. The reported leverage ratio was 3.2-to-1.0 against a permitted 5.25-to-1.0, and the interest coverage ratio was 2.7-to-1.0 against a minimum 2.0-to-1.0.
- Series B Convertible Preferred Stock issued to Starboard and certain franchisees had a carrying value of $251.3 million. The investment generated $252.5 million of gross proceeds and $7.2 million of issuance costs. It carries a 3.6% dividend and is convertible based on a $50.06 conversion price.
- The Company paid $19.6 million of dividends during the first six months, including common, pass-through and preferred dividends. No common-stock repurchases occurred in the period; the prior repurchase program expired February 27, 2019.
Material changes versus the prior comparable period
- Domestic company-owned restaurant sales fell 9.8% in the quarter and 12.4% year to date, driven by comparable-sales declines of 6.8% and 7.9% and lower equivalent units following refranchising activity.
- North America franchise royalties and fees declined 17.4% in the quarter and 23.5% year to date, reflecting negative comparable franchise sales and royalty reductions provided as franchise assistance.
- North America commissary sales declined 4.1% in the quarter and 6.1% year to date, primarily due to lower restaurant sales.
- International revenue declined 12.3% in the quarter and 13.5% year to date, mainly due to China refranchising and unfavorable foreign exchange. International franchise restaurant sales, excluding currency effects, increased 9.6% and 10.0%.
- General and administrative expense increased to $48.7 million in the quarter and $99.9 million year to date, from $39.0 million and $79.0 million. Drivers included special charges, higher professional and consulting fees, management incentive costs and the timing of the operators’ conference.
- Operating cash flow fell $41.3 million year to date, and free cash flow declined $43.0 million, reflecting lower earnings and unfavorable working-capital changes.
Guidance, outlook, risks and unusual items
- In July 2019, management announced an $80 million investment in marketing and brand initiatives and financial assistance for traditional North America franchisees, expected to be incurred approximately 50% in the second half of 2019 and 50% in 2020. The Company projected $50 million to $60 million of full-year charges.
- Second-quarter special charges were $5.4 million; six-month charges were $21.2 million. They included royalty relief, marketing-fund investments, legal and advisory costs, and a $5.9 million one-time mark-to-market adjustment related to preferred-stock options.
- Management identified negative consumer sentiment, declining North America comparable sales, competitive pricing and promotions, labor and commodity costs, supply-chain concentration, foreign exchange, Brexit-related uncertainty, technology and data-security risks, and food-safety risks as material business risks.
- Approximately 40 company-owned stores and certain U.S. properties were classified as held for sale, with total assets of $11.0 million and related lease liabilities of $4.2 million.
- Material litigation includes the Ameranth patent appeal, the Durling delivery-driver collective action involving 9,571 opt-in drivers, and a securities class action. No liabilities were recorded because management did not consider losses probable or reasonably estimable.
- Disclosure controls and procedures were not effective at quarter-end because of previously reported material weaknesses related to PJMF consolidation and complex VIE accounting. Remediation was underway but had not operated for a sufficient period to be deemed complete.
- The Company has material LIBOR-indexed contracts and is evaluating the potential transition to alternative reference rates.
Most important facts for investors to verify
- Whether the $80 million franchise-support and marketing program improves North America comparable sales and franchisee financial health.
- The sustainability of liquidity and covenant compliance as sales trends remain weak and the Company continues to fund dividends, royalty relief and strategic investments.
- The economic and voting dilution, dividend burden and future redemption or conversion implications of the Series B Preferred Stock.
- Whether PJMF consolidation controls are remediated and whether additional restatements or reporting effects arise.
- Progress on refranchising approximately 40 stores and the resulting effect on revenue mix, margins and debt reduction.
- Potential outcomes and financial exposure from disclosed litigation and lease guarantees, including approximately $10.0 million of maximum undiscounted payments on 94 contingent domestic lease obligations.