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Table of Contents

 

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

FORM 10-Q

 

(Mark One)

 

x

Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

For the quarterly period ended September 28, 2014

 

OR

 

o

Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

Commission File Number:  0-21660

 

PAPA JOHN’S INTERNATIONAL, INC.

(Exact name of registrant as specified in its charter)

 

Delaware

 

61-1203323

(State or other jurisdiction of

 

(I.R.S. Employer Identification

incorporation or organization)

 

number)

 

2002 Papa Johns Boulevard

Louisville, Kentucky  40299-2367

(Address of principal executive offices)

 

(502) 261-7272

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days:  Yes x  No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x  No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer x

 

Accelerated filer o

Non-accelerated filer o

 

Smaller reporting company o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No x

 

At October 28, 2014, there were outstanding 40,157,097 shares of the registrant’s common stock, par value $0.01 per share.

 

 

 



Table of Contents

 

INDEX

 

 

 

Page No.

PART I.

FINANCIAL INFORMATION

 

 

 

 

Item 1.

Financial Statements

 

 

 

 

 

Condensed Consolidated Balance Sheets — September 28, 2014 and December 29, 2013

2

 

 

 

 

Condensed Consolidated Statements of Income — Three and Nine Months Ended September 28, 2014 and September 29, 2013

3

 

 

 

 

Consolidated Statements of Comprehensive Income — Three and Nine Months Ended September 28, 2014 and September 29, 2013

4

 

 

 

 

Consolidated Statements of Cash Flows — Nine Months Ended September 28, 2014 and September 29, 2013

5

 

 

 

 

Notes to Condensed Consolidated Financial Statements

6

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

14

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

25

 

 

 

Item 4.

Controls and Procedures

26

 

 

 

PART II.

OTHER INFORMATION

 

 

 

 

Item 1.

Legal Proceedings

26

 

 

 

Item 1A.

Risk Factors

27

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

27

 

 

 

Item 6.

Exhibits

28

 

1



Table of Contents

 

PART 1. FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

Papa John’s International, Inc. and Subsidiaries

Condensed Consolidated Balance Sheets

 

(In thousands, except per share amounts)

 

September 28,
2014

 

December 29,
2013

 

 

 

(Unaudited)

 

 

 

Assets

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

17,148

 

$

13,670

 

Accounts receivable, net

 

57,262

 

53,203

 

Notes receivable, net

 

6,064

 

3,566

 

Inventories

 

34,428

 

23,035

 

Deferred income taxes

 

6,924

 

8,004

 

Prepaid expenses

 

11,881

 

14,336

 

Other current assets

 

9,815

 

9,226

 

Total current assets

 

143,522

 

125,040

 

Property and equipment, net

 

218,453

 

212,097

 

Notes receivable, less current portion, net

 

12,359

 

13,239

 

Goodwill

 

82,689

 

79,391

 

Other assets

 

35,158

 

34,524

 

Total assets

 

$

492,181

 

$

464,291

 

 

 

 

 

 

 

Liabilities and stockholders’ equity

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

34,273

 

$

35,653

 

Income and other taxes payable

 

10,837

 

4,401

 

Accrued expenses and other current liabilities

 

52,866

 

57,807

 

Total current liabilities

 

97,976

 

97,861

 

Deferred revenue

 

4,887

 

5,827

 

Long-term debt

 

224,684

 

157,900

 

Deferred income taxes

 

12,604

 

14,660

 

Other long-term liabilities

 

39,180

 

42,835

 

Total liabilities

 

379,331

 

319,083

 

 

 

 

 

 

 

Redeemable noncontrolling interests

 

8,970

 

7,024

 

 

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Preferred stock ($0.01 par value per share; no shares issued)

 

 

 

Common stock ($0.01 par value per share; issued 43,236 at September 28, 2014 and 42,796 at December 29, 2013)

 

432

 

428

 

Additional paid-in capital

 

144,022

 

137,552

 

Accumulated other comprehensive income

 

2,173

 

2,463

 

Retained earnings

 

77,268

 

41,297

 

Treasury stock (3,050 shares at September 28, 2014 and 1,129 shares at December 29, 2013, at cost)

 

(132,545

)

(44,066

)

Total stockholders’ equity, net of noncontrolling interests

 

91,350

 

137,674

 

Noncontrolling interests in subsidiaries

 

12,530

 

510

 

Total stockholders’ equity

 

103,880

 

138,184

 

Total liabilities, redeemable noncontrolling interests and stockholders’ equity

 

$

492,181

 

$

464,291

 

 

See accompanying notes.

 

2



Table of Contents

 

Papa John’s International, Inc. and Subsidiaries

Condensed Consolidated Statements of Income

(Unaudited)

 

 

 

Three Months Ended

 

Nine Months Ended

 

(In thousands, except per share amounts)

 

Sept. 28, 2014

 

Sept. 29, 2013

 

Sept. 28, 2014

 

Sept. 29, 2013

 

 

 

 

 

 

 

 

 

 

 

North America revenues:

 

 

 

 

 

 

 

 

 

Domestic Company-owned restaurant sales

 

$

169,076

 

$

152,662

 

$

517,269

 

$

465,713

 

Franchise royalties

 

22,131

 

19,419

 

65,728

 

60,382

 

Franchise and development fees

 

217

 

263

 

493

 

1,028

 

Domestic commissary sales

 

149,224

 

138,044

 

463,852

 

421,941

 

Other sales

 

23,359

 

13,566

 

49,704

 

38,617

 

International revenues:

 

 

 

 

 

 

 

 

 

Royalties and franchise and development fees

 

6,673

 

5,454

 

18,769

 

15,912

 

Restaurant and commissary sales

 

19,719

 

16,934

 

56,825

 

47,539

 

Total revenues

 

390,399

 

346,342

 

1,172,640

 

1,051,132

 

Costs and expenses:

 

 

 

 

 

 

 

 

 

Domestic Company-owned restaurant expenses:

 

 

 

 

 

 

 

 

 

Cost of sales

 

42,460

 

38,233

 

129,646

 

113,131

 

Salaries and benefits

 

45,835

 

41,701

 

139,223

 

127,026

 

Advertising and related costs

 

15,369

 

14,424

 

46,979

 

43,894

 

Occupancy costs

 

10,344

 

9,583

 

29,101

 

27,233

 

Other restaurant operating expenses

 

25,343

 

23,061

 

75,850

 

68,237

 

Total domestic Company-owned restaurant expenses

 

139,351

 

127,002

 

420,799

 

379,521

 

Domestic commissary expenses:

 

 

 

 

 

 

 

 

 

Cost of sales

 

116,908

 

107,930

 

364,302

 

326,529

 

Salaries and benefits

 

7,208

 

6,173

 

21,079

 

18,273

 

Other commissary operating expenses

 

15,013

 

15,262

 

47,083

 

45,908

 

Total domestic commissary expenses

 

139,129

 

129,365

 

432,464

 

390,710

 

Other operating expenses

 

22,794

 

12,510

 

47,446

 

35,094

 

International restaurant and commissary expenses

 

16,605

 

14,372

 

47,366

 

40,008

 

General and administrative expenses

 

33,671

 

31,780

 

104,199

 

98,064

 

Other general expenses

 

3,143

 

1,260

 

6,640

 

4,042

 

Depreciation and amortization

 

10,520

 

8,605

 

29,539

 

25,672

 

Total costs and expenses

 

365,213

 

324,894

 

1,088,453

 

973,111

 

Operating income

 

25,186

 

21,448

 

84,187

 

78,021

 

Net interest (expense) income

 

(968

)

(185

)

(2,323

)

147

 

Income before income taxes

 

24,218

 

21,263

 

81,864

 

78,168

 

Income tax expense

 

7,256

 

6,385

 

26,522

 

24,926

 

Net income before attribution to noncontrolling interests

 

16,962

 

14,878

 

55,342

 

53,242

 

Income attributable to noncontrolling interests

 

(887

)

(602

)

(3,208

)

(2,510

)

Net income attributable to the Company

 

$

16,075

 

$

14,276

 

$

52,134

 

$

50,732

 

 

 

 

 

 

 

 

 

 

 

Calculation of income for earnings per share:

 

 

 

 

 

 

 

 

 

Net income attributable to the Company

 

$

16,075

 

$

14,276

 

$

52,134

 

$

50,732

 

Increase in noncontrolling interest redemption value

 

(42

)

 

(81

)

 

Net income attributable to participating securities

 

(77

)

 

(295

)

 

Net income attributable to common shareholders

 

$

15,956

 

$

14,276

 

$

51,758

 

$

50,732

 

 

 

 

 

 

 

 

 

 

 

Basic earnings per common share

 

$

0.39

 

$

0.33

 

$

1.25

 

$

1.16

 

Diluted earnings per common share

 

$

0.39

 

$

0.32

 

$

1.23

 

$

1.13

 

 

 

 

 

 

 

 

 

 

 

Basic weighted average common shares outstanding

 

40,739

 

43,182

 

41,248

 

43,710

 

Diluted weighted average common shares outstanding

 

41,386

 

44,168

 

42,021

 

44,762

 

 

 

 

 

 

 

 

 

 

 

Dividends declared per common share

 

$

0.14

 

$

0.125

 

$

0.39

 

$

0.375

 

 

See accompanying notes.

 

3



Table of Contents

 

Papa John’s International, Inc. and Subsidiaries

Consolidated Statements of Comprehensive Income

(Unaudited)

 

 

 

Three Months Ended

 

Nine Months Ended

 

(In thousands)

 

Sept. 28, 2014

 

Sept. 29, 2013

 

Sept. 28, 2014

 

Sept. 29, 2013

 

 

 

 

 

 

 

 

 

 

 

Net income before attribution to noncontrolling interests

 

$

16,962

 

$

14,878

 

$

55,342

 

$

53,242

 

Other comprehensive income (loss), before tax:

 

 

 

 

 

 

 

 

 

Foreign currency translation adjustments

 

(1,634

)

1,980

 

(708

)

259

 

Interest rate swaps (1)

 

694

 

(529

)

247

 

(456

)

Other comprehensive income (loss), before tax

 

(940

)

1,451

 

(461

)

(197

)

Income tax effect:

 

 

 

 

 

 

 

 

 

Foreign currency translation adjustments

 

605

 

(733

)

262

 

(96

)

Interest rate swaps (2)

 

(256

)

196

 

(91

)

169

 

Income tax effect

 

349

 

(537

)

171

 

73

 

Other comprehensive income (loss), net of tax

 

(591

)

914

 

(290

)

(124

)

Comprehensive income before attribution to noncontrolling interests

 

16,371

 

15,792

 

55,052

 

53,118

 

Comprehensive income, redeemable noncontrolling interests

 

(724

)

(602

)

(3,066

)

(2,510

)

Comprehensive income, nonredeemable noncontrolling interests

 

(163

)

 

(142

)

 

Comprehensive income attributable to the Company

 

$

15,484

 

$

15,190

 

$

51,844

 

$

50,608

 

 


(1) Amounts reclassified out of accumulated other comprehensive income (“AOCI”) into net interest (expense) income included $250 and $749 for the three and nine months ended September 28, 2014, respectively and $165 and $254 for the three and nine months ended September 29, 2013, respectively.

 

(2) The income tax effects of amounts reclassified out of AOCI into net interest (expense) income were $92 and $277 for the three and nine months ended September 28, 2014, respectively and $61 and $94 for the three and nine months ended September 29, 2013, respectively.

 

See accompanying notes.

 

4



Table of Contents

 

Papa John’s International, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

(Unaudited)

 

 

 

Nine Months Ended

 

(In thousands)

 

Sept. 28, 2014

 

Sept. 29, 2013

 

 

 

 

 

 

 

Operating activities

 

 

 

 

 

Net income before attribution to noncontrolling interests

 

$

55,342

 

$

53,242

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

Provision for uncollectible accounts and notes receivable

 

1,714

 

1,130

 

Depreciation and amortization

 

29,539

 

25,672

 

Deferred income taxes

 

7,687

 

6,994

 

Stock-based compensation expense

 

5,958

 

5,642

 

Excess tax benefit on equity awards

 

(8,493

)

(4,108

)

Other

 

3,916

 

1,260

 

Changes in operating assets and liabilities, net of acquisitions:

 

 

 

 

 

Accounts receivable

 

(6,861

)

(4,666

)

Inventories

 

(9,792

)

(740

)

Prepaid expenses

 

2,461

 

410

 

Other current assets

 

(313

)

(129

)

Other assets and liabilities

 

3,887

 

(3,254

)

Accounts payable

 

(1,380

)

1,457

 

Income and other taxes payable

 

6,434

 

(4,511

)

Accrued expenses and other current liabilities

 

(5,163

)

(3,217

)

Deferred revenue

 

(110

)

(349

)

Net cash provided by operating activities

 

84,826

 

74,833

 

 

 

 

 

 

 

Investing activities

 

 

 

 

 

Purchases of property and equipment

 

(37,700

)

(38,537

)

Loans issued

 

(5,221

)

(3,830

)

Repayments of loans issued

 

3,371

 

3,687

 

Acquisitions, net of cash acquired

 

(4,264

)

 

Other

 

25

 

324

 

Net cash used in investing activities

 

(43,789

)

(38,356

)

 

 

 

 

 

 

Financing activities

 

 

 

 

 

Net proceeds on line of credit facility

 

66,784

 

31,742

 

Cash dividends paid

 

(16,119

)

(5,414

)

Excess tax benefit on equity awards

 

8,493

 

4,108

 

Tax payments for equity award issuances

 

(7,540

)

(1,862

)

Proceeds from exercise of stock options

 

4,752

 

4,193

 

Acquisition of Company common stock

 

(94,152

)

(69,137

)

Contributions from noncontrolling interest holders

 

1,086

 

850

 

Distributions to noncontrolling interest holders

 

(1,200

)

(3,200

)

Other

 

423

 

(501

)

Net cash used in financing activities

 

(37,473

)

(39,221

)

Effect of exchange rate changes on cash and cash equivalents

 

(86

)

37

 

Change in cash and cash equivalents

 

3,478

 

(2,707

)

Cash and cash equivalents at beginning of period

 

13,670

 

16,396

 

Cash and cash equivalents at end of period

 

$

17,148

 

$

13,689

 

 

See accompanying notes.

 

5



Table of Contents

 

Papa John’s International, Inc. and Subsidiaries

 

Notes to Condensed Consolidated Financial Statements (Unaudited)

 

September 28, 2014

 

1.              Basis of Presentation

 

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments, consisting of normal recurring accruals, considered necessary for a fair presentation have been included. Operating results for the nine months ended September 28, 2014 are not necessarily indicative of the results that may be expected for the fiscal year ended December 28, 2014. For further information, refer to the consolidated financial statements and footnotes thereto included in the Annual Report on Form 10-K for Papa John’s International, Inc. (referred to as the “Company,” “Papa John’s” or in the first person notations of “we,” “us” and “our”) for the year ended December 29, 2013.

 

2.              Significant Accounting Policies

 

Reclassifications

 

Certain prior year amounts in the condensed consolidated statements of income have been reclassified to conform to the current year presentation, which had no effect on current or previously reported net income.

 

Noncontrolling Interests

 

Papa John’s has joint ventures in which there are noncontrolling interests, including the following as of September 28, 2014 and September 29, 2013:

 

 

 

Number of
Restaurants

 

Restaurant Locations

 

Papa John’s
Ownership

 

Noncontrolling
Interest
Ownership

 

September 28, 2014

 

 

 

 

 

 

 

 

 

Star Papa, LP

 

82

 

Texas

 

51

%

49

%

Colonel’s Limited, LLC

 

56

 

Maryland and Virginia

 

70

%

30

%

PJ Minnesota, LLC

 

34

 

Minnesota

 

70

%

30

%

PJ Denver, LLC

 

25

 

Colorado

 

60

%

40

%

 

 

 

 

 

 

 

 

 

 

September 29, 2013

 

 

 

 

 

 

 

 

 

Star Papa, LP

 

78

 

Texas

 

51

%

49

%

Colonel’s Limited, LLC

 

52

 

Maryland and Virginia

 

70

%

30

%

PJ Minnesota, LLC

 

31

 

Minnesota

 

80

%

20

%

PJ Denver, LLC

 

25

 

Colorado

 

60

%

40

%

 

The noncontrolling interest holder’s ownership in PJ Minnesota, LLC increased from 20% to 30% during the third quarter of 2014 upon exercise of an option to acquire an additional 10% interest in the joint venture from the Company.

 

We are required to report consolidated net income at amounts attributable to the Company and the noncontrolling interests. Additionally, disclosures are required to clearly identify and distinguish between the interests of the Company and the interests of the noncontrolling owners, including a disclosure on the face of the condensed consolidated statements of income attributable to the noncontrolling interest holder.

 

6



Table of Contents

 

The income before income taxes attributable to the joint ventures for the three and nine months ended September 28, 2014 and September 29, 2013 was as follows (in thousands):

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

Sept. 28,

 

Sept. 29,

 

Sept. 28,

 

Sept. 29,

 

 

 

2014

 

2013

 

2014

 

2013

 

 

 

 

 

 

 

 

 

 

 

Papa John’s International, Inc.

 

$

1,387

 

$

805

 

$

4,979

 

$

3,597

 

Noncontrolling interests

 

887

 

602

 

3,208

 

2,510

 

Total income before income taxes

 

$

2,274

 

$

1,407

 

$

8,187

 

$

6,107

 

 

The following summarizes the redemption feature, location within the condensed consolidated balance sheets and the value at which the noncontrolling interests are recorded for each joint venture as of September 28, 2014:

 

Joint Venture

 

Redemption Feature

 

Location within the
Condensed Consolidated
Balance Sheets

 

Recorded Value

 

 

 

 

 

 

 

 

 

Star Papa, LP

 

Redeemable

 

Temporary equity

 

Carrying value

 

PJ Denver, LLC

 

Redeemable

 

Temporary equity

 

Redemption value

 

Colonel’s Limited, LLC

 

No redemption feature

 

Permanent equity

 

Carrying value

 

PJ Minnesota, LLC

 

No redemption feature

 

Permanent equity

 

Carrying value

 

 

The noncontrolling interest holders of two joint ventures have the option to require the Company to purchase their interests. Since redemption of the noncontrolling interests is outside of the Company’s control, the noncontrolling interests are presented in the caption “Redeemable noncontrolling interests” in the condensed consolidated balance sheets and include the following joint ventures:

 

·                  The Star Papa, LP agreement contains a redemption feature that is not currently redeemable, but it is probable to become redeemable in the future. Due to specific valuation provisions contained in the agreement, this noncontrolling interest has been recorded at its carrying value.

 

·                  The PJ Denver, LLC agreement contains a redemption feature that is currently redeemable and, therefore, this noncontrolling interest has been recorded at its current redemption value. The change in redemption value is recorded as an adjustment to “Redeemable noncontrolling interests” and “Retained earnings” in the condensed consolidated balance sheets.

 

The following summarizes changes in these redeemable noncontrolling interests (in thousands):

 

Balance at December 29, 2013

 

$

7,024

 

Net income

 

1,865

 

Change in redemption value

 

81

 

Balance at September 28, 2014

 

$

8,970

 

 

Through August 24, 2014, the Colonel’s Limited, LLC agreement contained a mandatory redemption clause and, accordingly, the Company recorded this noncontrolling interest as a liability at its redemption value in other long-term liabilities. The redemption value was adjusted at each reporting date and any change was recorded in interest expense. In the current quarter, the mandatory redemption clause was removed via a contract amendment to the operating agreement. Upon the removal of this redemption feature, the noncontrolling interest for Colonel’s Limited, LLC was reclassified from other long-term liabilities to stockholders’ equity at the recorded amount, which approximated fair value, with no impact to income before income taxes.  At September 28, 2014, the noncontrolling interest was recorded in stockholders’ equity at a carrying value of $11.5 million and was

 

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recorded at a redemption value of $10.8 million in other long-term liabilities at December 29, 2013. Future changes in the carrying value will be recorded in stockholders’ equity.

 

We recorded interest income of $25,000 through the date of the contract amendment in the third quarter of 2014 and $374,000 in the third quarter of 2013, and interest income of $4,000 and $1.1 million in the first nine months of 2014 and 2013, respectively.

 

Deferred Income Tax Accounts and Tax Reserves

 

We are subject to income taxes in the United States and several foreign jurisdictions. Significant judgment is required in determining our provision for income taxes and the related assets and liabilities. The provision for income taxes includes income taxes paid, currently payable or receivable and those deferred. We use an estimated annual effective rate based on expected annual income to determine our quarterly provision for income taxes. Discrete items are recorded in the quarter in which they occur.

 

Deferred tax assets and liabilities are determined based on differences between financial reporting and tax basis of assets and liabilities and are measured using enacted tax rates and laws that are expected to be in effect when the differences reverse. Deferred tax assets are also recognized for the estimated future effects of tax loss carryforwards. The effect on deferred taxes of changes in tax rates is recognized in the period in which the new tax is enacted. As a result, our effective tax rate may fluctuate. Valuation allowances are established when necessary on a jurisdictional basis to reduce deferred tax assets to the amounts we expect to realize. As of September 28, 2014, we had a net deferred tax liability of approximately $5.7 million.

 

Tax authorities periodically audit the Company. We record reserves and related interest and penalties for identified exposures as income tax expense. We evaluate these issues on a quarterly basis to adjust for events, such as statute of limitations expirations, court rulings or audit settlements, which may impact our ultimate payment for such exposures.

 

Fair Value Measurements and Disclosures

 

The Company is required to determine the fair value of financial assets and liabilities based on the price that would be received to sell the asset or paid to transfer the liability to a market participant. Fair value is a market-based measurement, not an entity specific measurement. The fair value of certain assets and liabilities approximates carrying value because of the short-term nature of the accounts, including cash, accounts receivable and accounts payable. The carrying value of our notes receivable net of allowances also approximates fair value. The fair value of the amount outstanding under our revolving credit facility approximates its carrying value due to its variable market-based interest rate. These assets and liabilities are categorized as Level 1 as defined below.

 

Certain assets and liabilities are measured at fair value on a recurring basis and are required to be classified and disclosed in one of the following categories:

 

·                  Level 1: Quoted market prices in active markets for identical assets or liabilities.

·                  Level 2: Observable market-based inputs or unobservable inputs that are corroborated by market data.

·                  Level 3: Unobservable inputs that are not corroborated by market data.

 

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Our financial assets and liabilities that were measured at fair value on a recurring basis as of September 28, 2014 and December 29, 2013 are as follows (in thousands):

 

 

 

Carrying

 

Fair Value Measurements

 

 

 

Value

 

Level 1

 

Level 2

 

Level 3

 

 

 

 

 

 

 

 

 

 

 

September 28, 2014

 

 

 

 

 

 

 

 

 

Financial assets:

 

 

 

 

 

 

 

 

 

Cash surrender value of life insurance policies (a)

 

$

17,814

 

$

17,814

 

$

 

$

 

Interest rate swap (b)

 

218

 

 

218

 

 

 

 

 

 

 

 

 

 

 

 

Financial liabilities:

 

 

 

 

 

 

 

 

 

Interest rate swap (b)

 

75

 

 

75

 

 

 

 

 

 

 

 

 

 

 

 

December 29, 2013

 

 

 

 

 

 

 

 

 

Financial assets:

 

 

 

 

 

 

 

 

 

Cash surrender value of life insurance policies (a)

 

$

16,798

 

$

16,798

 

$

 

$

 

 

 

 

 

 

 

 

 

 

 

Financial liabilities:

 

 

 

 

 

 

 

 

 

Interest rate swap (b)

 

76

 

 

76

 

 

 


(a)         Represents life insurance policies held in our non-qualified deferred compensation plan.

(b)         The fair values of our interest rate swaps are based on the sum of all future net present value cash flows. The future cash flows are derived based on the terms of our interest rate swaps, as well as considering published discount factors, and projected London Interbank Offered Rates (“LIBOR”).

 

There were no transfers among levels within the fair value hierarchy during the nine months ended September 28, 2014.

 

Variable Interest Entities

 

Papa John’s domestic restaurants, both Company-owned and franchised, participate in Papa John’s Marketing Fund, Inc. (“PJMF”), a nonstock corporation designed to operate at break-even for the purpose of designing and administering advertising and promotional programs for all participating domestic restaurants. PJMF is a variable interest entity as it does not have sufficient equity to fund its operations without ongoing financial support and contributions from its members. Based on the ownership and governance structure and operating procedures of PJMF, we have determined that we do not have the power to direct the most significant activities of PJMF and therefore are not the primary beneficiary. Accordingly, we determined that consolidation is not appropriate.

 

Recent Accounting Pronouncement

 

In May 2014, the Financial Accounting Standards Board issued “Revenue from Contracts with Customers” (Accounting Standards update 2014-09), a comprehensive new revenue recognition standard that will supersede nearly all existing revenue recognition guidance under GAAP. This update requires companies to recognize revenue at amounts that reflect the consideration to which the company expects to be entitled in exchange for those goods or services at the time of transfer. In doing so, companies will need to use more judgment and make more estimates than under today’s guidance. Such estimates may include identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation. Companies can either apply a full retrospective adoption or a modified retrospective adoption.

 

We are required to adopt the new requirements in the first quarter of 2017. We are currently evaluating the method of adoption and its impact of the new requirements on our consolidated financial statements. We currently do not believe the impact will be significant.

 

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3.              Stockholders’ Equity

 

In the fourth quarter of 2013, we completed a two-for-one stock split of our outstanding shares of common stock in the form of a stock dividend. The stock dividend was distributed on December 27, 2013 with approximately 21.0 million shares of common stock distributed. In conjunction with the stock split, we also retired shares held in treasury. The per-share and share amounts for 2013 in the accompanying condensed consolidated financial statements and notes to the financial statements have been adjusted to reflect the stock split.

 

4.              Calculation of Earnings Per Share

 

We compute earnings per share using the two-class method. The two-class method requires an earnings allocation formula that determines earnings per share for common shareholders and participating security holders according to dividends declared and participating rights in undistributed earnings. We consider time-based restricted stock awards to be participating securities because holders of such shares have non-forfeitable dividend rights. Under the two-class method, undistributed earnings allocated to participating securities are subtracted from net income attributable to the Company in determining net income attributable to common shareholders.

 

Additionally, in accordance with Accounting Standards Codification (“ASC”) 480, Distinguishing Liabilities from Equity, the increase in the redemption value for the noncontrolling interest of PJ Denver, LLC reduces income attributable to common shareholders.

 

The calculations of basic and diluted earnings per common share are as follows (in thousands, except per-share data):

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

Sept. 28,

 

Sept. 29,

 

Sept. 28,

 

Sept. 29,

 

 

 

2014

 

2013

 

2014

 

2013

 

 

 

 

 

 

 

 

 

 

 

Basic earnings per common share:

 

 

 

 

 

 

 

 

 

Net income attributable to the Company

 

$

16,075

 

$

14,276

 

$

52,134

 

$

50,732

 

Increase in noncontrolling interest redemption value

 

(42

)

 

(81

)

 

Net income attributable to participating securities

 

(77

)

 

(295

)

 

Net income attributable to common shareholders

 

$

15,956

 

$

14,276

 

$

51,758

 

$

50,732

 

 

 

 

 

 

 

 

 

 

 

Weighted average common shares outstanding

 

40,739

 

43,182

 

41,248

 

43,710

 

Basic earnings per common share

 

$

0.39

 

$

0.33

 

$

1.25

 

$

1.16

 

 

 

 

 

 

 

 

 

 

 

Diluted earnings per common share:

 

 

 

 

 

 

 

 

 

Net income attributable to common shareholders

 

$

15,956

 

$

14,276

 

$

51,758

 

$

50,732

 

 

 

 

 

 

 

 

 

 

 

Weighted average common shares outstanding

 

40,739

 

43,182

 

41,248

 

43,710

 

Dilutive effect of outstanding equity awards (a)

 

647

 

986

 

773

 

1,052

 

Diluted weighted average common shares outstanding

 

41,386

 

44,168

 

42,021

 

44,762

 

Diluted earnings per common share

 

$

0.39

 

$

0.32

 

$

1.23

 

$

1.13

 

 


(a)         Excludes 270 and 208 awards for the three and nine months ended September 28, 2014 and 24 and 129 awards for the three and nine months ended September 29, 2013, as the effect of including such awards would have been antidilutive.

 

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5.              Acquisition of Restaurants

 

For the nine-month period ended September 28, 2014, we completed the acquisition of 12 franchised Papa John’s restaurants located in various markets as part of four separate transactions. The aggregate purchase price for these four transactions was $5.0 million, which was comprised of cash payments of approximately $4.3 million, amounts withheld in escrow of approximately $300,000, and the cancellation of approximately $400,000 in accounts and notes receivable due to us. These acquisitions were accounted for by the purchase method of accounting, whereby operating results subsequent to the acquisition date are included in our consolidated financial results.

 

The aggregate purchase price of the acquisitions has been allocated based on initial fair value estimates as follows (in thousands):

 

Property and equipment

 

$

453

 

Reacquired franchise right

 

844

 

Goodwill

 

3,568

 

Other, including cash

 

117

 

Total purchase price

 

$

4,982

 

 

The excess of the purchase price over the aggregate fair value of net assets acquired was allocated to goodwill, all of which is expected to be deductible for tax purposes.

 

6.              Debt

 

Our debt is comprised entirely of a revolving line of credit. The outstanding balance was $224.7 million as of September 28, 2014 and $157.9 million as of December 29, 2013.

 

In September 2010, we entered into a five-year, $175 million unsecured revolving credit facility, which was amended in November 2011 to extend the maturity date to November 30, 2016. On April 30, 2013, we amended and restated our revolving credit facility to increase the amount available for borrowing to $300 million and extend the maturity date to April 30, 2018.  On October 31, 2014, we amended our unsecured revolving line of credit facility (“Amended Line”) to increase the amount available to $400 million and extend the maturity date to October 31, 2019.  Additionally, we have the option to increase the Amended Line an additional $100 million.  The interest rate charged on outstanding balances is LIBOR plus 75 to 175 basis points.  The commitment fee on the unused balance ranges from 15 to 25 basis points. The remaining availability under the Amended Line, reduced for outstanding letters of credit approximates $148.4 million.

 

The revolving credit facility contains customary affirmative and negative covenants, including financial covenants requiring the maintenance of specified fixed charges and leverage ratios. At September 28, 2014, we were in compliance with these covenants.

 

In August 2011, we entered into an interest rate swap agreement that resulted in a fixed rate of 0.53%, instead of the variable rate of LIBOR, with a notional amount of $50 million and a maturity date of August 2013. On December 31, 2012, we amended our interest rate swap agreement to extend the maturity date to December 30, 2015. The amendment resulted in a change to the fixed rate (to 0.56% from 0.53%) but did not impact the notional amount of the interest rate swap agreement. On July 30, 2013, we terminated the $50 million swap and entered into a new $75 million swap. The new swap has an interest rate of 1.42% and a maturity date of April 30, 2018. The termination of the previous swap did not have a material impact on our 2013 results. In May 2014, we entered into a $50 million forward interest rate swap with an interest rate of 1.36%, an effective date of December 30, 2014 and a maturity date of April 30, 2018.

 

Our swaps are derivative instruments that are designated as cash flow hedges because the swaps provide a hedge against the effects of rising interest rates on borrowings. The effective portion of the gain or loss on the swaps is reported as a component of accumulated other comprehensive income and reclassified into earnings in the same period or periods during which the swaps affect earnings. Gains or losses on the swaps representing either hedge

 

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ineffectiveness or hedge components excluded from the assessment of effectiveness are recognized in current earnings. Amounts payable or receivable under the swaps are accounted for as adjustments to interest expense. As of September 28, 2014, the swaps are highly effective cash flow hedges with no ineffectiveness for the three- and nine-month periods ended September 28, 2014.

 

The weighted average interest rates for our revolving credit facility, including the impact of the previously mentioned swap agreements, were 1.8% and 1.7% for the three and nine months ended September 28, 2014, respectively. Interest paid, including payments made or received under the swap, was $1.0 million and $431,000 for the three months ended September 28, 2014 and September 29, 2013, respectively, and $2.6 million and $1.2 million for the nine months ended September 28, 2014 and September 29, 2013, respectively. As of September 28, 2014, the portion of the $143,000 net interest rate swap asset that would be reclassified into earnings during the next twelve months as interest income approximates $40,000.

 

7.                    Litigation

 

Litigation

 

The Company is involved in a number of lawsuits, claims, investigations and proceedings, including those specifically identified below, consisting of intellectual property, employment, consumer, commercial and other matters arising in the ordinary course of business. In accordance with ASC 450, Contingencies, the Company has made accruals with respect to these matters, where appropriate, which are reflected in the Company’s consolidated financial statements. We review these provisions at least quarterly and adjust these provisions to reflect the impact of negotiations, settlements, rulings, advice of legal counsel and other information and events pertaining to a particular case.

 

Perrin v. Papa John’s International, Inc. and Papa John’s USA, Inc. is a conditionally certified collective action filed in August 2009 in the United States District Court, Eastern District of Missouri, alleging that delivery drivers were not reimbursed for mileage and expenses in accordance with the Fair Labor Standards Act. Approximately 3,900 drivers out of a potential class size of 28,800 have opted into the action. In late December 2013, the District Court granted a motion for class certification in five additional states, which will add approximately 15,000 plaintiffs to the case. The trial is scheduled for August 2015.

 

We intend to vigorously defend against all claims in this lawsuit. However, given the inherent uncertainties of litigation, the outcome of this case cannot be predicted and the amount of any potential loss cannot be reasonably estimated. A negative outcome in this case could have a material adverse effect on the Company.

 

8.              Segment Information

 

We have five reportable segments: domestic Company-owned restaurants, domestic commissaries, North America franchising, international operations, and “all other” units.

 

The domestic Company-owned restaurant segment consists of the operations of all domestic (“domestic” is defined as contiguous United States) Company-owned restaurants and derives its revenues principally from retail sales of pizza and side items, such as breadsticks, cheesesticks, chicken poppers, chicken wings, cookie and dessert pizza and soft drinks to the general public. The domestic commissary segment consists of the operations of our regional dough production and product distribution centers and derives its revenues principally from the sale and distribution of food and paper products to domestic Company-owned and franchised restaurants. The North America franchising segment consists of our franchise sales and support activities and derives its revenues from sales of franchise and development rights and collection of royalties from our franchisees located in the United States and Canada. The international operations segment principally consists of Company-owned restaurants in China and distribution sales to franchised Papa John’s restaurants located in the United Kingdom, Mexico and China and our franchise sales and support activities, which derive revenues from sales of franchise and development rights and the collection of royalties from our international franchisees. International franchisees are defined as all franchise operations outside of the United States and Canada. All other business units that do not meet the quantitative thresholds for determining reportable segments, which are not operating

 

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segments, we refer to as our “all other” segment, which consists of operations that derive revenues from the sale, principally to Company-owned and franchised restaurants, of printing and promotional items, risk management services, and information systems and related services used in restaurant operations, including our point-of-sale system, online and other technology-based ordering platforms.

 

Generally, we evaluate performance and allocate resources based on profit or loss from operations before income taxes and intercompany eliminations. Certain administrative and capital costs are allocated to segments based upon predetermined rates or actual estimated resource usage. We account for intercompany sales and transfers as if the sales or transfers were to third parties and eliminate the activity in consolidation.

 

Our reportable segments are business units that provide different products or services. Separate management of each segment is required because each business unit is subject to different operational issues and strategies. No single external customer accounted for 10% or more of our consolidated revenues.

 

Our segment information is as follows (in thousands):

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

Sept. 28, 2014

 

Sept. 29, 2013

 

Sept. 28, 2014

 

Sept. 29, 2013

 

 

 

 

 

 

 

 

 

 

 

Revenues from external customers:

 

 

 

 

 

 

 

 

 

Domestic Company-owned restaurants

 

$

169,076

 

$

152,662

 

$

517,269

 

$

465,713

 

Domestic commissaries

 

149,224

 

138,044

 

463,852

 

421,941

 

North America franchising

 

22,348

 

19,682

 

66,221

 

61,410

 

International

 

26,392

 

22,388

 

75,594

 

63,451

 

All others

 

23,359

 

13,566

 

49,704

 

38,617

 

Total revenues from external customers

 

$

390,399

 

$

346,342

 

$

1,172,640

 

$

1,051,132

 

 

 

 

 

 

 

 

 

 

 

Intersegment revenues:

 

 

 

 

 

 

 

 

 

Domestic commissaries

 

$

53,830

 

$

46,408

 

$

160,143

 

$

139,320

 

North America franchising

 

574

 

530

 

1,761

 

1,635

 

International

 

78

 

69

 

236

 

209

 

All others

 

6,421

 

3,718

 

18,238

 

10,204

 

Total intersegment revenues

 

$

60,903

 

$

50,725

 

$

180,378

 

$

151,368

 

 

 

 

 

 

 

 

 

 

 

Income (loss) before income taxes:

 

 

 

 

 

 

 

 

 

Domestic Company-owned restaurants

 

$

8,133

 

$

5,535

 

$

32,069

 

$

24,666

 

Domestic commissaries

 

8,897

 

6,473

 

26,174

 

26,278

 

North America franchising

 

19,023

 

16,516

 

56,389

 

52,134

 

International

 

1,436

 

945

 

4,071

 

2,152

 

All others

 

(298

)

590

 

(150

)

2,402

 

Unallocated corporate expenses

 

(12,242

)

(8,544

)

(35,405

)

(28,475

)

Elimination of intersegment losses (profits)

 

(731

)

(252

)

(1,284

)

(989

)

Total income before income taxes

 

$

24,218

 

$

21,263

 

$

81,864

 

$

78,168

 

 

 

 

 

 

 

 

 

 

 

Property and equipment:

 

 

 

 

 

 

 

 

 

Domestic Company-owned restaurants

 

$

205,553

 

 

 

 

 

 

 

Domestic commissaries

 

106,815

 

 

 

 

 

 

 

International

 

26,317

 

 

 

 

 

 

 

All others

 

44,686

 

 

 

 

 

 

 

Unallocated corporate assets

 

164,718

 

 

 

 

 

 

 

Accumulated depreciation and amortization

 

(329,636

)

 

 

 

 

 

 

Net property and equipment

 

$

218,453

 

 

 

 

 

 

 

 

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Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Overview

 

Papa John’s International, Inc. (referred to as the “Company,” “Papa John’s” or in the first person notations of “we,” “us” and “our”) began operations in 1984. At September 28, 2014, there were 4,537 Papa John’s restaurants (741 Company-owned and 3,796 franchised) operating in all 50 states and in 36 international countries and territories. Our revenues are principally derived from retail sales of pizza and other food and beverage products to the general public by Company-owned restaurants, franchise royalties, sales of franchise and development rights, sales to franchisees of food and paper products, printing and promotional items, risk management services, and information systems and related services used in their operations.

 

The results of operations are based on the preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States (“GAAP”). The preparation of consolidated financial statements requires management to select accounting policies for critical accounting areas and make estimates and assumptions that affect the amounts reported in the consolidated financial statements. Significant changes in assumptions and/or conditions in our critical accounting policies could materially impact the operating results. See “Notes 1 and 2” of “Notes to Condensed Consolidated Financial Statements” for a discussion of the basis of presentation and the significant accounting policies.

 

Restaurant Progression

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

Sept. 28, 2014

 

Sept. 29, 2013

 

Sept. 28, 2014

 

Sept. 29, 2013

 

 

 

 

 

 

 

 

 

 

 

North America Company-owned:

 

 

 

 

 

 

 

 

 

Beginning of period

 

672

 

654

 

665

 

648

 

Opened

 

5

 

2

 

9

 

8

 

Closed

 

(1

)

 

(3

)

 

Acquired from franchisees

 

7

 

 

12

 

 

End of period

 

683

 

656

 

683

 

656

 

International Company-owned:

 

 

 

 

 

 

 

 

 

Beginning of period

 

59

 

51

 

58

 

48

 

Opened

 

 

4

 

1

 

7

 

Closed

 

(1

)

 

(1

)

 

End of period

 

58

 

55

 

58

 

55

 

North America franchised:

 

 

 

 

 

 

 

 

 

Beginning of period

 

2,614

 

2,588

 

2,621

 

2,556

 

Opened

 

37

 

48

 

86

 

111

 

Closed

 

(14

)

(41

)

(65

)

(72

)

Sold to Company

 

(7

)

 

(12

)

 

End of period

 

2,630

 

2,595

 

2,630

 

2,595

 

International franchised:

 

 

 

 

 

 

 

 

 

Beginning of period

 

1,142

 

959

 

1,084

 

911

 

Opened

 

54

 

36

 

123

 

105

 

Closed

 

(30

)

(5

)

(41

)

(26

)

End of period

 

1,166

 

990

 

1,166

 

990

 

Total restaurants - end of period

 

4,537

 

4,296

 

4,537

 

4,296

 

 

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FOCUS System

 

The Company is implementing a new, proprietary point-of-sale system (“FOCUS”) in substantially all domestic system-wide restaurants. As of September 28, 2014, we had installed FOCUS in almost 50% of our domestic restaurants, including all Company-owned restaurants and almost 800 franchised restaurants. Substantial completion is expected to occur by the end of the first quarter of 2015.

 

The costs related to implementing FOCUS are projected to decrease income before income taxes by approximately $4.0 million in 2014, or a $0.06 negative impact on diluted earnings per share, as compared to 2013. For the three and nine months ended September 28, 2014, the impact was a $1.2 million and $2.3 million reduction in income before income taxes, or a $0.02 and $0.04 reduction in diluted earnings per share, respectively. FOCUS had the following impact on our condensed consolidated statements of income for the three and nine months ended September 28, 2014 (in thousands):

 

 

 

Three Months

 

Nine Months

 

 

 

Sept. 28,

 

Sept. 28,

 

 

 

2014

 

2014

 

 

 

 

 

 

 

Franchise royalties (a)

 

$

(63

)

$

(68

)

Other sales (b)

 

9,708

 

9,848

 

Other operating expenses (c)

 

(9,773

)

(10,424

)

Depreciation and amortization (d) 

 

(1,064

)

(1,643

)

Net decrease in income before income taxes

 

$

(1,192

)

$

(2,287

)

 

 

 

 

 

 

Diluted earnings per common share

 

$

(0.02

)

$

(0.04

)

 


(a)         Incentive program tied to franchisee rollout of FOCUS.

(b)         Represents revenues for equipment installed at domestic franchised restaurants.

(c)          Includes cost of sales associated with equipment installed at franchised restaurants and other costs to support the rollout of the program.

(d)         Includes depreciation expense for both the capitalized software and for equipment installed at Company-owned restaurants which are being depreciated over five to seven years.

 

As part of the rollout, we have partnered with a third party to offer a financing option for this system to our franchisees. The arrangement with the third party requires us to offer a guarantee for the loans. The term of these loans will be five years or less and will require us to perform under the guarantee when a franchisee has a late payment in excess of 60 days. The guarantee is limited to the greater of 10% of all loans or 100% of all loans that have higher risk profiles. Higher risk profiles are determined based on pre-established criteria including length of time in business, credit rating, and other factors. We have the ability to decline funding on higher risk loans.

 

As of September 28, 2014, we had a guarantee liability of approximately $100,000.

 

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Results of Operations

 

Summary of Operating Results - Segment Review

 

Discussion of Revenues

 

Consolidated revenues were $390.4 million for the three months ended September 28, 2014, an increase of $44.1 million, or 12.7%, over the corresponding 2013 period. For the nine months ended September 28, 2014, total revenues were $1.17 billion, an increase of $121.5 million, or 11.6%, over the corresponding 2013 period. The increases in revenues for the three and nine months ended September 28, 2014, were primarily due to the following:

 

·                  Domestic Company-owned restaurant sales increased $16.4 million, or 10.8%, and $51.6 million, or 11.1% for the three and nine months ended September 28, 2014, respectively, primarily due to increases of 8.3% and 9.1% in comparable sales. “Comparable sales” represents the change in year-over-year sales for the same base of restaurants for the same fiscal periods.

·                  North America franchise royalty revenue increased approximately $2.7 million, or 14.0%, and $5.3 million or 8.9%, for the three and nine months ended September 28, 2014, respectively, primarily due to increases of 7.1% and 7.2% in comparable sales. The three-month period was also favorably impacted by lower performance-based royalty incentives.

·                  Domestic commissary sales increased $11.2 million, or 8.1%, and $41.9 million, or 9.9%, for the three and nine months ended September 28, 2014, respectively, due to increases in the prices of certain commodities, primarily cheese and meats, and increases in sales volumes for the nine-month period.

·                  Other sales increased $9.8 million, or 72.2%, and $11.1 million, or 28.7%, for the three and nine months, respectively, primarily due to FOCUS equipment sales to franchisees. See the FOCUS System section for additional information.

·                  International royalties and franchise and development fees increased approximately $1.2 million, or 22.4%, and $2.9 million, or 18.0%, for the three and nine months ended September 28, 2014, respectively, primarily due to increases in the number of restaurants and increases in comparable sales of 5.5% and 6.9%, calculated on a constant dollar basis.

·                  International restaurant and commissary sales increased $2.8 million, or 16.4%, and $9.3 million, or 19.5%, respectively, primarily due to increases in our United Kingdom commissary revenues, due to increases in units and higher comparable sales. For the nine months ended September 28, 2014, China Company-owned restaurant sales also increased primarily due to an increase in the number of units.

 

Discussion of Operating Results

 

Third quarter 2014 income before income taxes was $24.2 million compared to $21.3 million in the prior year comparable period, or an increase of $3.0 million, or 13.9%. Income before income taxes was $81.9 million for the nine months ended September 28, 2014, compared to $78.2 million for the prior year comparable period, or an increase of $3.7 million, or 4.7%.

 

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Income before income taxes is summarized in the following table on a reporting segment basis (in thousands):

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

Sept. 28,

 

Sept. 29,

 

Increase

 

Sept. 28,

 

Sept. 29,

 

Increase

 

(In thousands)

 

2014

 

2013

 

(Decrease)

 

2014

 

2013

 

(Decrease)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Domestic company-owned restaurants

 

$

8,133

 

$

5,535

 

$

2,598

 

$

32,069

 

$

24,666

 

$

7,403

 

Domestic commissaries

 

8,897

 

6,473

 

2,424

 

26,174

 

26,278

 

(104

)

North America franchising

 

19,023

 

16,516

 

2,507

 

56,389

 

52,134

 

4,255

 

International

 

1,436

 

945

 

491

 

4,071

 

2,152

 

1,919

 

All others

 

(298

)

590

 

(888

)

(150

)

2,402

 

(2,552

)

Unallocated corporate expenses

 

(12,242

)

(8,544

)

(3,698

)

(35,405

)

(28,475

)

(6,930

)

Elimination of intersegment losses (profits)

 

(731

)

(252

)

(479

)

(1,284

)

(989

)

(295

)

Total income before income taxes (a)

 

$

24,218

 

$

21,263

 

$

2,955

 

$

81,864

 

$

78,168

 

$

3,696

 

 


(a)               Includes FOCUS system rollout costs of approximately $1.2 million and $2.3 million for the three and nine months ended September 28, 2014, respectively. See the FOCUS System section for additional information.

 

The increases of $3.0 million, or 13.9%, and $3.7 million, or 4.7%, for the three- and nine-month periods, respectively, were primarily due to the following:

 

·                  Domestic Company-owned Restaurant Segment. Domestic Company-owned restaurants’ income before income taxes increased approximately $2.6 million and $7.4 million for the three and nine months ended September 28, 2014, respectively, compared to the corresponding prior year periods. The increases were primarily due to the 8.3% and 9.1% increases in comparable sales, partially offset by the impact of higher commodity costs. The market price for cheese averaged $2.14 and $2.16 per pound for the three- and nine-month periods in 2014, respectively, compared to $1.74 and $1.73 per pound in the prior year comparable periods. Additionally, the results for the three- and nine-month periods of 2014 include approximately $450,000 and $640,000 of depreciation expense associated with FOCUS hardware costs, respectively.

 

·                  Domestic Commissary Segment. Domestic commissaries’ income before income taxes increased approximately $2.4 million and decreased approximately $100,000 for the three and nine months ended September 28, 2014, respectively, compared to the corresponding prior year periods. The increase for the three-month period was primarily due to a higher margin of approximately $3.4 million, partially offset by higher costs associated with various ongoing commissary initiatives. The decrease for the nine-month period was primarily due to higher insurance costs of approximately $1.1 million and higher costs associated with ongoing commissary initiatives that were substantially offset by a higher margin of approximately $3.8 million. We manage commissary results on a full year basis and anticipate the 2014 full year profit margin will approximate 2013.

 

·                  North America Franchising Segment. North America Franchising income before income taxes increased $2.5 million and $4.3 million for the three and nine months ended September 28, 2014, respectively, compared to the corresponding prior year periods. The increases were primarily due to higher royalties from the increases of 7.1% and 7.2% in comparable sales.  Additionally, the three-month period was favorably impacted by lower performance-based royalty incentives.

 

·                  International Segment. Income before income taxes increased approximately $500,000 and $1.9 million for the three and nine months ended September 28, 2014, respectively, compared to the corresponding prior year periods. The increases were primarily due to increases in units and comparable sales increases of 5.5% and 6.9%, which resulted in both higher royalties and an improvement in United Kingdom commissary results. These increases were partially offset by unfavorable results at our China Company-owned restaurant operations, including losses of approximately $1.4 million and $2.3 million for the three and nine months ended September 28, 2014, respectively, compared to losses of $400,000

 

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and $850,000 in the prior year periods. The 2014 periods include an impairment charge of approximately $700,000 for eight restaurants.

 

·                  All Others Segment. The “All Others” reporting segment, which primarily includes our online and mobile ordering business and our wholly-owned print and promotions subsidiary, Preferred Marketing Solutions, decreased approximately $900,000 and $2.6 million for the three and nine months ended September 28, 2014, respectively, compared to the corresponding prior year periods. The decreases were primarily due to higher infrastructure costs to support our digital ordering business and a lower margin at our print and promotions business, including higher costs for the nine-month period from a discounted direct mail campaign.

 

·                  Unallocated Corporate Expenses. Unallocated corporate expenses increased approximately $3.7 million and $6.9 million for the three and nine months ended September 28, 2014, respectively, compared to the corresponding 2013 periods. The components of unallocated corporate expenses were as follows (in thousands):

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

Sept. 28,

 

Sept. 29,

 

Increase

 

Sept. 28,

 

Sept. 29,

 

Increase

 

 

 

2014

 

2013

 

(Decrease)

 

2014

 

2013

 

(Decrease)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

General and administrative (a)

 

$

9,009

 

$

7,470

 

$

1,539

 

$

27,484

 

$

24,515

 

$

2,969

 

Net interest expense (income) (b)

 

991

 

176

 

815

 

2,377

 

(107

)

2,484

 

Depreciation

 

1,980

 

1,629

 

351

 

5,594

 

5,020

 

574

 

Other (income) expense

 

(234

)

(731

)

497

 

(1,130

)

(953

)

(177

)

FOCUS system rollout costs (c)

 

496

 

 

496

 

1,080

 

 

1,080

 

Total unallocated corporate expenses

 

$

12,242

 

$

8,544

 

$

3,698

 

$

35,405

 

$

28,475

 

$

6,930

 

 


(a)         The increases in unallocated general and administrative costs were primarily due to higher salaries, benefits, and equity compensation costs, increased professional and legal fees and higher insurance costs.

(b)         The increases in net interest expense (income) were primarily due to a higher average outstanding debt balance with a higher effective interest rate. Additionally, the three- and nine-month periods of 2013 included an approximate $375,000 and $1.1 million benefit from a decrease in the redemption value of a mandatorily redeemable noncontrolling interest in a joint venture.

(c)          Includes depreciation expense for capitalized FOCUS software development costs and other costs to support the rollout of the program.

 

Diluted earnings per share were $0.39 and $0.32 for the three months ended September 28, 2014 and September 29, 2013, respectively, and were $1.23 and $1.13 for the nine months ended September 28, 2014 and September 29, 2013, respectively. Shares outstanding decreased 6.3% and 6.1% for the three- and nine-month periods, which resulted in increases in diluted earnings per share of $0.03 and $0.08 for the three and nine months ended September 28, 2014, respectively, from the prior year comparable periods.

 

Review of Consolidated Operating Results

 

Revenues. Domestic Company-owned restaurant sales were $169.1 million for the three months ended September 28, 2014, compared to $152.7 million for the same period in 2013, and $517.3 million for the nine months ended September 28, 2014, compared to $465.7 million for the same period in 2013. The increases of $16.4 million and $51.6 million were primarily due to the previously mentioned increases of 8.3% and 9.1% in comparable sales and increases of 2.6% and 2.4% in equivalent units during the three and nine months ended September 28, 2014, respectively. “Equivalent units” represents the number of restaurants open at the beginning of a given period, adjusted for restaurants opened, closed, acquired or sold during the period on a weighted average basis.

 

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North America franchise royalties were $22.1 million and $65.7 million for the three and nine months ended September 28, 2014, respectively, representing increases of approximately $2.7 million or 14.0%, and $5.3 million, or 8.9%, from the comparable periods in the prior year. The increases in royalties were primarily due to the previously mentioned increases of 7.1% and 7.2% in comparable sales and increases of 0.7% and 1.2% in equivalent units during the three and nine months ended September 28, 2014. The three-month period was also favorably impacted by lower performance-based royalty incentives. North America franchise sales increased 7.7% to $484.3 million for the three months ended September 28, 2014, compared to $450.0 million for the same period in 2013, and increased 8.2% to $1.511 billion for the nine months ended September 28, 2014, compared to $1.396 billion for the same period in 2013. Franchise restaurant sales are not included in Company revenues; however, our domestic royalty revenue is derived from these sales.

 

Average weekly sales for comparable units include restaurants that were open throughout the periods presented below. The comparable sales base for domestic Company-owned and North America franchised restaurants, respectively, includes restaurants acquired by the Company or divested to franchisees during the previous twelve months. Average weekly sales for non-comparable units include restaurants that were not open throughout the periods presented below and include non-traditional sites. Average weekly sales for non-traditional units not subject to continuous operations are calculated based upon actual days open.

 

The comparable sales base and average weekly sales for 2014 and 2013 for domestic Company-owned and North America franchised restaurants consisted of the following:

 

 

 

Three Months Ended

 

 

 

September 28, 2014

 

September 29, 2013

 

 

 

Company

 

Franchised

 

Company

 

Franchised

 

 

 

 

 

 

 

 

 

 

 

Total domestic units (end of period)

 

683

 

2,630

 

656

 

2,595

 

Equivalent units

 

667

 

2,496

 

650

 

2,479

 

Comparable sales base units

 

649

 

2,311

 

633

 

2,264

 

Comparable sales base percentage

 

97.3

%

92.6

%

97.4

%

91.3

%

Average weekly sales - comparable units

 

$

19,628

 

$

15,306

 

$

18,241

 

$

14,385

 

Average weekly sales - total non-comparable units (a)

 

$

15,081

 

$

10,179

 

$

11,666

 

$

9,494

 

Average weekly sales - all units

 

$

19,504

 

$

14,926

 

$

18,071

 

$

13,962

 

 

 

 

Nine Months Ended

 

 

 

September 28, 2014

 

September 29, 2013

 

 

 

Company

 

Franchised

 

Company

 

Franchised

 

 

 

 

 

 

 

 

 

 

 

Total domestic units (end of period)

 

683

 

2,630

 

656

 

2,595

 

Equivalent units

 

662

 

2,513

 

647

 

2,483

 

Comparable sales base units

 

644

 

2,302

 

633

 

2,257

 

Comparable sales base percentage

 

97.3

%

91.6

%

97.8

%

90.9

%

Average weekly sales - comparable units

 

$

20,209

 

$

15,879

 

$

18,610

 

$

14,885

 

Average weekly sales - total non-comparable units (a)

 

$

13,759

 

$

10,356

 

$

11,564

 

$

9,769

 

Average weekly sales - all units

 

$

20,026

 

$

15,415

 

$

18,458

 

$

14,419

 

 


(a) Includes 150 traditional and 204 non-traditional units as of September 28, 2014 and 193 traditional and 178 non-traditional units as of September 29, 2013.

 

Domestic commissary sales increased 8.1% to $149.2 million for the three months ended September 28, 2014, from $138.0 million in the comparable 2013 period and increased 9.9% to $463.9 million for the nine months ended September 28, 2014, from $421.9 million in the comparable 2013 period. The increases were primarily due to increases in the prices of certain commodities, primarily cheese and meats, and increases in restaurant sales volumes for the nine-month period.

 

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Other sales increased approximately $9.8 million, or 72.2%, and $11.1 million, or 28.7%, for the three and nine months ended September 28, 2014, respectively, primarily due to FOCUS equipment sales to franchisees.

 

International royalties and franchise and development fees increased approximately $1.2 million, or 22.4%, for the three months ended September 28, 2014, and increased $2.9 million, or 18.0%, for the nine months ended September 28, 2014, from the prior comparable periods. The increases were due to an increase in units of 17.8% and comparable sales increases of 5.5% and 6.9%, calculated on a constant dollar basis, for the three- and nine-month periods, respectively. International franchise sales increased 19.6% to $139.4 million for the three months ended September 28, 2014, compared to $116.6 million for the same period in 2013, and increased 22.5% to $410.3 million for the nine months ended September 28, 2014, compared to $334.9 million for the same period in 2013. International franchise sales are not included in Company revenues; however, our international royalty revenue is derived from these sales.

 

International restaurant and commissary sales increased $2.8 million, or 16.4%, for the three months ended September 28, 2014, and increased $9.3 million, or 19.5%, for the nine months ended September 28, 2014, from the prior comparable periods primarily due to increases in our United Kingdom commissary revenues due to increases in units and higher comparable sales. For the nine months ended September 28, 2014, China Company-owned restaurant sales also increased primarily due to an increase in the number of units.

 

Costs and expenses.  The restaurant operating margin for domestic Company-owned units was 17.6% for the three months ended September 28, 2014, compared to 16.8% for the same period in 2013, and 18.6% for the nine months ended September 28, 2014, compared to 18.5% for the same period in 2013. The margins were comprised of the following changes for the three and nine months ended September 28, 2014:

 

·                  Cost of sales was 0.1% and 0.8% higher for the three and nine months ended September 28, 2014, as compared to the same periods in 2013, primarily due to higher commodity costs, primarily cheese and meats, somewhat offset by a higher ticket average.

·                  Salaries and benefits were 0.2% and 0.4% lower as a percentage of sales for the three and nine months ended September 28, 2014, as compared to the same periods in 2013. The decreases were primarily due to the benefit of higher sales.

·                  Advertising and related costs as a percentage of sales were 0.4% and 0.3% lower for the three and nine months ended September 28, 2014, as compared to the same periods in 2013, primarily due to the benefit of higher sales.

·                  Occupancy costs and other operating costs, on a combined basis, were 0.3% and 0.2% lower for the three and nine months ended September 28, 2014, as compared to the same periods in 2013, primarily due to the benefit of higher sales.

 

Domestic commissary margin was 6.8% for the three months ended September 28, 2014, compared to 6.3% for the corresponding period in 2013, and 6.8% for the nine months ended September 28, 2014, compared to 7.4% for the corresponding period in 2013, and consisted of the following differences:

 

·                  Cost of sales was 0.2% and 1.2% higher as a percentage of sales for the three and nine months ended September 28, 2014 primarily due to higher cheese costs, which have a fixed-dollar markup. As cheese prices are higher, food cost as a percentage of sales is higher.

·                  Salaries and benefits were 4.8% and 4.5% for the three-month periods of 2014 and 2013, respectively, and 4.5% and 4.3% for the nine-month periods of 2014 and 2013, respectively. The higher costs were attributable to ongoing commissary initiatives, including in-house distribution.

·                  Other commissary operating expenses were 1.0% and 0.7% lower as a percentage of sales. The lower operating expenses as a percentage of sales were due to higher sales from higher commodities, including cheese prices. Total operating expenses increased in dollars for the nine-month period primarily due to higher insurance claims costs of approximately $1.1 million.

 

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International restaurant and commissary expenses were 84.2% of international restaurant and commissary sales in the third quarter of 2014 as compared to 84.9% in the third quarter of 2013 and were 83.4% for the nine months ended September 28, 2014 as compared to 84.2% for the corresponding 2013 period. The decreases as a percentage of sales were primarily due to lower operating expenses in the United Kingdom primarily due to the benefit of higher sales.

 

General and administrative (“G&A”) costs were $33.7 million, or 8.6%, of revenues for the three months ended September 28, 2014, compared to $31.8 million, or 9.2%, of revenues for the same period in 2013. G&A costs were $104.2 million, or 8.9%, of revenues for the nine months ended September 28, 2014, compared to $98.1 million, or 9.3%, of revenues for the same period in 2013. The increases of $1.9 million and $6.1 million for the three- and nine-month periods were primarily due to the following:

 

·                  Unallocated corporate G&A expenses increased due to higher salaries, benefits, and equity compensation costs, increased professional and legal fees and higher insurance costs.

·                  Domestic Company-owned restaurant supervisor bonuses increased due to higher sales.

 

Additionally, the nine-month period included higher international G&A costs due to infrastructure and promotional activity costs.

 

Other general expenses reflected net expense of $3.1 million for the three months ended September 28, 2014, compared to $1.3 million for the comparable period in 2013, and $6.6 million for the nine months ended September 28, 2014, compared to $4.0 million for the comparable period in 2013, as detailed below (in thousands):

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

Sept. 28,

 

Sept. 29,

 

Increase

 

Sept. 28,

 

Sept. 29,

 

Increase

 

 

 

2014

 

2013

 

(Decrease)

 

2014

 

2013

 

(Decrease)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Franchise and development incentives (a)

 

$

1,313

 

$

1,121

 

$

192

 

$

3,845

 

$

3,232

 

$

613

 

Disposition and impairment losses (b)

 

1,105

 

168

 

937

 

1,418

 

546

 

872

 

Provision (credit) for uncollectible accounts and notes receivable

 

546

 

(16

)

562

 

1,100

 

254

 

846

 

Supplier marketing income

 

(250

)

(250

)

 

(750

)

(750

)

 

Other

 

429

 

237

 

192

 

1,027

 

760

 

267

 

Total other general expenses

 

$

3,143

 

$

1,260

 

$

1,883

 

$

6,640

 

$

4,042

 

$

2,598

 

 


(a)         Represents incentives provided to domestic franchisees for opening new restaurants.

(b)         The 2014 periods include an impairment charge of approximately $700,000 for eight Company-owned restaurants in China.

 

Depreciation and amortization was $10.5 million (2.7% of revenues) for the three months ended September 28, 2014, compared to $8.6 million (2.5% of revenues) for the same 2013 period, and $29.5 million (2.5% of revenues) for the nine months ended September 28, 2014, compared to $25.7 million (2.4% of revenues) for the 2013 period. The increases in depreciation expense were due to incremental depreciation related to both our New Jersey commissary dough production capital expenditures and our FOCUS capitalized software costs and equipment costs at Company-owned restaurants.

 

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Net interest (expense) income. Net interest (expense) income consisted of the following for the three and nine months ended September 28, 2014 and September 29, 2013 (in thousands):

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

Sept. 28,

 

Sept. 29,

 

(Increase)

 

Sept. 28,

 

Sept. 29,

 

(Increase)

 

 

 

2014

 

2013

 

Decrease

 

2014

 

2013

 

Decrease

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest expense - line of credit (a)

 

$

(1,114

)

$

(646

)

$

(468